First year of trading and provisional tax

What are a taxpayer’s provisional tax obligations in their first year of trading?

This is a question we receive a lot. In fact, there is certainly a lot of confusion out there.

As most know, their first year of trading is not tax-free. However, when income tax is due and payable depends on a taxpayer’s residual income tax (RIT) for the year and if they are a ‘new provisional taxpayer’.

So, with that in mind, we explain below how the provisional tax rules work for the 2018 tax year onwards.

First year of trading: RIT is less than $60,000

Any income tax due for the year is due on your terminal tax date.

Interest will apply from this date if a taxpayer does not pay by then.

However, if the RIT is more than $5000 in their first year of trading, they will be a provisional taxpayer for the following year.

First year of trading: RIT is $60,000 or more

Inland Revenue (IR) may charge interest if you fall into the ‘new provisional taxpayer’ category.

The new provisional taxpayer criteria are different for individuals and companies/trusts.

Individuals are a new provisional taxpayer if:

• Their RIT for that tax year is $60,000 or more
• Their RIT in each of the four previous tax years was $5000 or less
• They stopped receiving income from employment and started to receive income from a taxable activity during that tax year.

Companies/trusts are a new provisional taxpayer if:

• Their RIT for that tax year is $60,000 or more
• They did not receive taxable income from a taxable activity in any of the four previous years
• They started receiving income from a taxable activity during that tax year.

Please take note of the different criteria for individuals and companies/trusts. This catches taxpayers out.

It is important to mention the term ‘taxable activity’ has the same meaning as it does in section 6 Goods and Services Tax Act 1985. However, for the purposes of provisional tax, the exclusion in the Act pertaining to GST-exempt supplies does not apply.

As such, determining if you are a new provisional taxpayer can be tricky in some instances.

From what instalment(s) will IR charge interest for new provisional taxpayers?

IR may charge interest (see the current rate here) on the number of provisional tax payments a taxpayer could have made during the first year of trading if you meet the new provisional taxpayer criteria.

Of course, that number depends on the date on which their business starts trading.

For someone with a 31 March balance date, refer to the table below.

These dates will differ if your balance date isn’t 31 March or you file GST returns on a six-monthly basis.

The amount due at each provisional tax instalment

So, what happens if you meet the new provisional taxpayer criteria in your first year of trading?

Well, put simply, IR will divide your RIT for the year by the number of instalments you were liable to pay per the table above.

For instance, say your business starts trading on 1 October and your RIT for the year was $69,000.

IR will charge interest from two provisional tax dates: 15 January and 7 May. The amount on which interest will accrue at each date will be $34,500.

On the positive side, late payment penalties will not apply.

Reducing exposure to IR interest

Taxpayers may wish to make provisional tax payments in their first year of trading to mitigate their exposure to IR interest if they expect their RIT is going to be $60,000 or more.

If they are an individual or a partner in a partnership and meet certain criteria, they may also get an early payment discount of 6.7 percent on these payments.

TMNZ’s Flexitax lets you reduce the IR interest cost on the tax owing by a significant amount.

This is done by applying surplus tax paid to IR on the date it was originally due against your liability. IR treats this as if you paid on time, eliminating any interest and late payment penalties incurred.

This article has been written in general terms only. You should not rely upon this to provide specific information without also obtaining appropriate professional advice after detailed examination of your situation.