Can AIM taxpayers use tax pooling?
A taxpayer cannot use tax pooling to defer payment of, or settle, provisional tax instalments calculated under the accounting income method (AIM).
However, Tax Management NZ (TMNZ) can help AIM taxpayers with terminal tax or when they receive a notice of reassessment.
What does tax pooling legislation say about AIM?
Legislation in the Income Tax Act 2007 clearly states that a taxpayer can use tax pooling funds to satisfy “a provisional tax liability other than under the AIM method”.
Please refer to sections RP17-RP21 of the Act for further information.
Why IRD doesn’t allow tax pooling to assist with AIM payments?
Inland Revenue (IRD) says tax pooling manages taxpayers’ uncertainty around provisional tax payments and their exposure to interest.
Consistent with this objective, pooling is not currently available for tax types where someone has certainty of their liability at the time of payment (for example, GST).
Given the payments made under AIM are calculated on actual accounting profit, taxpayers will have certainty about what's due.
As such, it's IRD’s view that it's not appropriate to allow tax pooling for provisional tax payments calculated under AIM.
What does that mean for you?
IRD will reject the use of any tax pooling funds to satisfy an underpaid AIM instalment. As a result, late payment penalties and interest will continue to show on a taxpayer account.
They will, however, accept the use of tax pooling funds to settle a terminal tax liability. The same applies if an AIM taxpayer has additional tax to pay after receiving a notice of reassessment.
Please be mindful of these facts when entering arrangements with TMNZ.
It’s also an important consideration before electing to use AIM to calculate provisional tax.
That's because paying tax when income is earned is not necessarily the same as when cash is received.
If someone is unable to pay an AIM instalment on time or in full due to cashflow constraints, the safety net of tax pooling will not be available to reduce their exposure to interest and eliminate late payment penalties.
You're more than welcome to contact TMNZ if you have any questions.
AIM and tax pooling
Legislation prevents taxpayers from using tax pooling to pay AIM provisional tax instalments.
We are issuing this reminder as IRD notifies us they are seeing several tax pooling transactions for these types of payments.
Section RP17B (2)(a) Income Tax Act 2007 says an amount held in a tax pooling account on behalf of a taxpayer can only be used to satisfy a liability for “provisional tax other than under the AIM method”.
That means that a taxpayer using this provisional tax method is unable to use TMNZ to defer an upcoming AIM instalment or reduce their interest cost if they fail to make this payment on time or in full.
IRD will reject these transfers.
The only time an AIM user can use tax pooling is for terminal tax – for example, an amount that’s due on 7 April – or if they receive a notice of reassessment from IRD.
This is something accountants need to be aware of before signing clients up to this option.
Why IRD doesn’t allow tax pooling
IRD says it is not appropriate for taxpayers to use tax pooling for AIM provisional tax instalments because payments under this method:
- Have certainty.
- More closely match income flows of a business.
- Have no exposure to IRD interest (assuming a taxpayer pays the amount due in full and on time).
The Tax Pooling Intermediary Association, of which TMNZ is a member, and Chartered Accountants ANZ disagrees with that viewpoint. They say it assumes a taxpayer has the necessary cashflow to make their payments – but that is not always the case.
You can read both sides' argument here.
Usage of AIM
Uptake of AIM has been poor since it came into effect for the 2019 income year. According to IRD figures last year, only 1100 taxpayers are using this method. That works out to be about 10 percent of those eligible.
There are two IRD articles promoting AIM this year – yet curiously neither cites the current number of active users despite waxing lyrical about the benefits. This suggests it remains low.
TMNZ’s view is AIM is compliance heavy and will only suit a small handful of taxpayers.
Accounting income method: When cashflow doesn't match accounting profit
IRD’s marketing material boasts the accounting income method (AIM) means taxpayers only pay provisional tax when they make a profit.
But what it neglects to convey is what happens if an AIM
user making a profit has no money in their bank account to pay tax when it is
due.
The answer? Bad things. IRD charges interest and penalties – and there is very little they can do to mitigate the financial consequences.
Tax pooling, for instance, is not available to them. (We’ll explain IRD’s rationale as to why it isn't further on in this article.)
Indeed, an issue with using accounting profit as the basis of AIM payments is it assumes a taxpayer has the necessary cashflow to pay tax.
As those earning income from business activity know, that is
not always the case.
For instance, take a business that concludes the sale of a
large piece of equipment and finishes installing it. They will derive the
income for tax purposes at that time.
However, if the customer significantly delays payment or the
terms of supply mean the customer will pay the price over many months, the business
will not have the cashflow to pay provisional tax.
As such, they will incur steep IRD interest (soon to be 8.35 percent) and late payment penalties if they fail to pay the taxman on time.
Now if the taxpayer was using another method to calculate their provisional tax payments, they will have the ability to use tax pooling to make this payment when it suits their cashflow.
No worries. All good in the prov. tax hood.
But those using the accounting income method DO NOT enjoy this luxury. Legislation prevents them from using tax pooling. (Tax pooling can only help with terminal tax or reassessments if a taxpayer is using AIM.)
This hardly seems fair, does it?
Is it right IRD restricts the use of tax pooling for accounting income method taxpayers?
It was something the Tax Pooling Intermediary Association, of which TMNZ is a member, brought to officials’ attention when they were seeking submissions in 2016.
They felt the absence of any fallback mechanism such as tax
pooling will put additional stress on taxpayers to pay a liability under AIM
when they may not have enough cash.
“This type of situation is inconsistent with the policy
intent of easing the burden on taxpayers and encouraging them to pay the right
amount of tax at the right time without incurring penalties and could easily be
mitigated by allowing tax pooling to be used with the AIM method.
“Feedback we have received from engaging with our SME
clients is that the most important factor they have to deal with when paying
taxes is cashflow.”
Chartered Accountants ANZ echoed similar sentiments in its submission, saying IRD’s analysis on AIM “ignores the cashflow element to a business”.
As an example, they cite a company that makes strong sales –
but may not have the funds to pay provisional tax if debtors are not paying or if
the owner is re-investing cash to grow the business.
“There is no reason to exclude AIM taxpayers from tax
pooling.
“Tax pooling will enable the AIM taxpayer to meet their obligations without incurring IRD interest or penalties. Denying AIM taxpayers this flexibility at times when cashflow is tight is poor design.”
IRD’s position on AIM and tax pooling
In reply, IRD felt it was not appropriate for taxpayers to use tax pooling for AIM provisional tax payments.
That’s because payments under the accounting income method
have certainty, more closely match the income flows of a business and have no exposure
to IRD interest (assuming a taxpayer pays the amount due on time of course).
“The use of tax pooling for provisional tax payments throughout the income year provides certainty to taxpayers when payments are uncertain. It also assists in situations when provisional tax payments made under the estimate or uplift methods are not matched to the income flows of the business.
“Officials therefore believe that AIM effectively removes any benefit to a business from using tax pooling during the income year.”
They argue mismatches in cashflow to tax payments occur when tax adjustments move the taxable profit further away from accounting profit. Under the accounting income method, there is “minimal movement” away from accounting profit.
Moreover, IRD feels taxpayers could use their standard banking facilities if they have cashflow concerns.
If cashflow problems were to persist, they can choose to use a provisional tax method that better aligns with their cashflow.
“Pooling itself does not operate as a pure financial
institution with regard to the short-term loans, rather it facilitates the sale
and purchase of tax paid at different dates.”
However, the Tax Pooling Intermediary Association says pooling is more than just the sale and purchase of tax at different dates and IRD is missing the point.
“Tax pooling has evolved … and is now used extensively by taxpayers as a cashflow management tool, to enable them to pay their income tax when cashflow from their business allows.”
The fact of the matter
Whatever someone agrees or disagrees with IRD's stance, the fact remains the same.
Taxpayers using the accounting income method must be aware
of the potential consequences they face if they are making profit but have insufficient
cash to pay tax.
And as they cannot use tax pooling to defer AIM payments if they are experiencing a cashflow problem, they need to consider if it is the right option for them. It can also be quite a compliance-heavy method, especially for taxpayers with significant year-end adjustments.
In other words, do not take IRD's marketing spin as gospel.