Provisional Tax – timing is everything

Provisional tax is a system that requires taxpayers with Residual Income Tax (RIT) of more than $5,000 to make payments throughout the year to ease the pressure of their tax burden. For some taxpayers (with stable results) this becomes a part of their operating cycle and won’t cause too much discomfort.

However, with a move from a period of stable growth into recession, high inflation, and the impacts of recent events such as COVID and Tropical Cyclones, as well as the impacts of one-off transactions (large sales, or Brightline Property sales) many will need to reassess their payments.

Before running through some strategies and tips for Provisional Tax lets covers off the basics:

Provisional Tax – some basics

Taxpayers who have RIT over $5,000 become provisional taxpayers, and will be liable to pay tax instalments (commonly 28th August, 15th January and 7th May if you have a 31 March balance date) – this is commonly calculated using one of the 3 methods below.

Standard Uplift

This method is based on the taxpayer's previous year's income. The IRD provides a percentage increase, and taxpayers are required to pay that percentage more than they paid in the previous year. This method is relatively straightforward, offers protections for Safe Harbour taxpayers, as well as improved flexibility for taxpayers who exceed $60,000 of Residual Income Tax.

Estimation

Taxpayers can estimate their expected income for the current tax year and pay tax based on that estimate. This method requires more accuracy and record-keeping, but it allows for more flexibility. Note that underpayments using this method will exposes taxpayers to penalties and UOMI.

Accounting Income Method (AIM)

AIM is a new and more accurate way of paying provisional tax introduced in 2018. It is designed for small businesses with turnover under $5 million. With AIM, taxpayers make payments based on their actual accounting profit each month. This method aligns tax payments more closely with income earned but does require regular reporting to the IRD and can be tough on cashflow if you experience extreme fluctuations month to month.

Provisional Tax Tips and Strategies

1)      Plan – regardless of the method used it is important to plan where cash will come from to make provisional tax payments – this is critical to understand as a business grows and will likely be required to make tax payments in arrears and advance – a key example of the cash generation and obligation gap.

If a company makes $100,000 of profit in FY23 and wasn’t a provisional taxpayer they would be required to make a $28,000 terminal payment in April 2024, while also making payments of $9,800 (1/3rd of 105% of $28,000) towards FY24 provisional tax.

2)      Measure – regularly track profit, assess forecasts to help calculate what your obligation is likely to be and impacts on operational cashflows.

3)      Timing is everything – working with your advisor to understand the timing of when your tax return is filed as this could have a large impact on timing of payments. A year with a large increase in profit will trigger a subsequent increase in your obligation to pay tax but might also coincide with a return to normal trading, or a year with lower profits – although tax is still payable it might prevent a large obligation unnecessarily.

4)      Tax Pools such as Tax Traders, are great tools to assist with meeting your tax obligation with an increased level of flexibility, if cash is needed for asset acquisition (not a Jet ski) or to purchase trading stock that will in turn generate profit and cash a tax pool is perfect to make sure you have the correct tax at the correct date without missing out on great opportunities. This will also remove any late payment penalties and reduce interest.

5)      Safe Harbour – a taxpayer who is a safe harbour taxpayer has RIT under $60,000 and the IRD acknowledges that calculating the exact amount of tax due is onerous – these taxpayers will not attract UOMI on any underpaid tax until terminal tax date, but will be hit with Late Payment Penalties – what this means is any additional tax needs not be paid until April following year end, but it is important instalments are met to avoid penalties. This is only available to those using Standard Uplift.

Taxpayers who exceed $60,000 are permitted to make their 3rd payment based on expected results (be it higher, or lower) – and will only be exposed to interest from this date on any variance. This is not a formal estimation, but we would suggest making the IRD aware, so any future credits or refunds aren’t allocated to the expected payment.

6)      New Provisional Taxpayer – this is a trick for new players, literally. If you are new to business and exceed $60,000 in your first year, there is a requirement to make payments as if you were a Provisional Taxpayer with interest calculated from dates when tax would have been due. If you think this might be you speak to your advisor to make a plan.

There is no escaping tax, if you make profit (which we all hope to do) there will be tax payments to make. Ensuring that the approach works best for your specific business and situation is important to both stay on top of your liability, while not crippling business in times of change. In many cases (Standard Uplift) the IRD is expecting tax based on prior results – they aren’t aware of what is happening in your business now. A close relationship with your advisor will mean you are on the same page, aware of obligations while also options that work for you, as well as making sure there are no unexpected consequences in the future.

This article is not taxation advice, and each situation is client specific so please get in touch with the Direct team today to discuss the best tax payment options for your business.