Hopefully we didn’t lose you with the Cheezels analogy. But just in case, here’s a clear definition of provisional tax.
Provisional tax is a type of tax you pay in instalments. This helps you manage your income tax a little more easily, as you can pay in chunks rather than in one lump sum at the end of the year. These chunks are calculated using the tax you paid in the previous tax year.
Did you pay more than $5000 tax after your tax return last year? If so, you’ll have to pay provisional tax this year. Before the 2020 financial year end, the cut-off point was $2500.
You’re classed as a provisional taxpayer in New Zealand if you earn money from any of the following:
Of course, if you’re still in your first year of business, you won’t pay provisional tax. That’s because you don’t have any tax history from the previous year to go off.
Still with us?
Four options here. We’re given a choice because some will work better for your business than others. If you’re not sure, we can help!
1. The Standard Method
This is the method we see most often - it should be your go-to if you’re confident your income will increase over the next year.
It takes your residual income tax from the previous year and gives it a 5% uplift, then divides that by the number of instalments. Grab a calculator and multiple the residual tax from last year by 1.05, and you’re there. By the way, residual income tax (RIT) is the amount of income tax you pay for the year, minus any PAYE and other tax credits you may be entitled to, apart from Working for Families Tax Credits.
Let’s see that in action.
Say Eli has an RIT of $6000 from the previous financial year. He’ll have to pay provisional tax of $6000 x 1.05 = $6300 in the current financial year. This $6300 is divided into three equal instalments, usually paid on:
You’ll be expected to pay these chunks by specific dates, so remember to put money aside. And then remember to pay them to stay in the IRD’s good books.
2. The Estimation Method
Pick a number, any number. For the estimation method, you’re given an empty box and you can put whatever number you like in that box.
But before you go inputting a big fat ‘0’ and moving onto the next thing on your to-do list, be aware. While reducing your provisional tax to 0 means you won’t have to pay provisional tax, you’ll be penalised if you have residual tax to pay at the end of the year which is higher than the estimated amount.
We urge our clients to steer clear of the estimation method, because the chances of getting it wrong are high. The only times we’d recommend this is when a client is either:
3. The AIM Method
The newest and shiniest method that gets accountants like us excited is the AIM (Accounting Income Method).
This approach leans on Xero and takes away the guessing games and the waiting around. AIM works out your tax liability based on the actual income and expenses you’ve collected over a certain period. Then you simply pay the taxes on the profit made for that period.
So, you only pay tax on your profits as and when you earn them. You’ll stay in control of your financial targets because you’ll always know how much tax needs to be paid - and when. If you’re a new or growing company, or your income is a bit up and down, we’ll usually recommend AIM for you.
Here’s an example.
Jenny’s Pies & Fries Limited makes a $6000 profit over the April to May period. Based on their AIM return, they have to pay taxes of $1500 on this profit. So they fill out their AIM return and make this provisional tax payment.
The next time Jenny files their AIM return, it would be for the June to July period.
From June to July, Pies & Fries pulls in a $5000 profit, which gets added to their previous period’s profit of $6000. In total, they’ve made $11,000 worth of profit for the financial year. They have to pay $2800 worth of taxes on this amount, but since they’ve already paid $1500, this brings the return amount down to $1300.
4. The Ratio Method
If you’re registered for GST and would rather pay your provisional tax payments and GST payments together, this option could be the one you need.
The ratio option lets you line up your provisional tax payments with your business's cash flow. It works by basing these payments on a percentage of your GST-taxable supplies. If you’re feeling drawn to this option, let the IRD know at the beginning of the tax year.
This is a good choice for seasonal or varied income, but you do have to pay it every 2 months - which some consider a downside.
This type of date involves more paying tax than pigging out on sushi though, sorry.
If you’re filling out your tax return yourself, you’ll need to pay your residual income tax bill by the 7th of February the next year.
And, if you think you might struggle to meet any of the due dates, contact Inland Revenue as early as possible! They’re not as scary as you might think, and can usually help you work something out.
If you use a tax agent or accountant like BOM, first of all - go you! Second of all - you’ll need to pay your residual income tax bill by the 7th of April the next year.
Who woulda’ thunk provisional tax could be so interesting? And even more fun than sharing a sleeping bag with the creepy crawlies of New Zealand’s backyard?
Take away the stress and confusion with BOM. Book an obligation-free discovery call and let’s get your business on track. No missed deadlines. No IRD penalties. No smashing your calculator to pieces while you try and work out how much you owe.