Provisional tax. Just the very thought of those two words is enough to send a chill up the spine of many a business owner. Difficult to get right and expensive to get wrong, provisional tax has been the source of frustration for many over the years.
After all, the current rules are somewhat unfair. They assume you possess clairvoyant-like powers and can predict your income tax liability in advance – and you are hit with interest (currently 8.27%) by Inland Revenue if you underpay.
However, having to pay it is about to get better – much better, in fact – for thousands of small- and medium-sized businesses across New Zealand with new provisional tax rules coming into effect from next month to coincide with the start of the 2018 tax year.
They apply to those using the standard method to calculate their provisional tax payments. The standard method means you base your payments on 105% of last year’s income tax liability (or 110% of the previous year’s liability if your return has not been filed). Most businesses use this method.
Changes to how and when IRD apply interest for taxpayers using the standard method will provide greater certainty over payments and reduce compliance costs. Here’s what you need to know:
The biggest change applies to smaller taxpayers using what IRD calls the ‘safe harbour’.
- Your actual income tax liability is less than $60,000 and…
- You paid the amounts of tax required as per the standard method at your three provisional tax dates for that year.
- You will not be charged IRD interest if you did not pay enough provisional tax, provided any final balance is paid by your terminal tax date.
Previously the safe harbour threshold was $50,000 and applied to individuals only.
Medium and large taxpayers
The second change affects other taxpayers.
- Your actual income tax liability is $60,000 or more and…
- You paid provisional tax for that year based on the standard method.
- You will not be charged IRD interest if you paid the amounts of tax due as per the standard method at your first and second provisional tax dates for that year, even if your actual liability is higher.
- The final balance will be due at your third provisional tax date. IRD interest applies on any underpayment of tax from the third provisional tax date.
Things to remember
These changes apply to those who use the standard method to pay provisional tax. Taxpayers using the estimation or GST ratio method will face the same rules as before.
You will be charged IRD interest and late payment penalties if you do not make your payments on the dates they are due. As such, it’s important to discuss options with your accountant if you are going to struggle to pay on time.
For businesses who cannot make payments on the dates IRD requires them to be made, or have a more productive use for the funds, an IRD-approved tax pooling intermediary can provide some flexibility over how and when you settle your income tax obligations, without incurring late payment penalties and reducing interest costs.
Overall, the new provisional tax rules are part of the biggest shake-up to the New Zealand tax system in years and IRD should be applauded for making the system fairer.
They allow business owners to get on with what they do best – running and growing their business.
And that can only be a good thing.