Danny Pritchard
September 12, 2024
Whether you're a new business owner or have been in the game for years, provisional tax can be a complex and daunting topic. But fear not! We have compiled all the necessary information to help demystify the process and ensure you meet your tax obligations without any hassle. So grab a cup of coffee, sit back, and let's unravel the mysteries of provisional tax together.
Provisional tax in New Zealand is a system that requires businesses (and individuals) to pre-pay their income tax in installments throughout the year, rather than in a lump sum at the end of the tax year. This system helps to ensure that the government receives a steady stream of tax revenue and helps taxpayers to better manage their cash flow.
Typically, if your tax bill is more than $5000, you must pay provisional tax. There are 3 different options for paying provisional tax: Standard (can be estimated), Ratio and AIM.
1) Standard option
This is the default option. If your tax bill for the previous financial year is more than $5000, then IRD will usually put you on the standard option automatically, unless you (or your accountant) notify them.
To work out your provisional tax, IRD take your residual income tax from the previous year and add on 5% (to cater for any growth in your business). To work out each installment you can divide this amount by three as you’ll generally pay your tax in three installments, which are due on 28th August, 15th January and 7th of May.
Note that you will need to pay tax for that last financial year as well as pre-paying those installments in the current financial year (as you are pre-paying).
For example, if your company income tax was $6000 for the year ending 31 March 2024, then $6000 will be payable for that tax year. Then on top of this IRD adds on the 5% which gives us $6300 for the 2025 Tax year, which would be divided into 3 installments of $2100 due on the 28th of August 2024, 15th Jan 2025 and finally 7th May 2025.
At the end of the financial year you paid provisional tax for, if your actual tax is higher than the provisional paid, you may be required to pay additional tax at the end of the year. If the actual taxable income is lower than the estimated income, then you will be refunded.
2. Estimation option
The estimation option can help you avoid overpaying or underpaying your provisional tax. This method is structured in the same way as the standard method but instead of IRD working out your predicted tax bill for the financial year using their method, you can estimate your tax yourself and pay accordingly.
Since your provisional tax is calculated based on the previous year, you may use this method if your business had a great year last year and the current year is looking much less profitable, you have stopped trading or decided to go on payroll (PAYE).
You can estimate your tax on my myIR or by calling IRD.
Please note you need to be careful as if you underestimate the amount you may be subject to penalties and interest. Here we suggest talking to your accountant (or us!).
The payments will be due on the same dates as the standard method and the amount will be your estimate divided by 3. Or if the estimation is below $5k, you will be taken off provisional entirely and just need to pay a lump sum after the financial year.
3. AIM (Accounting Income Method)
The newest method that uses accounting software (like Xero and MYOB) 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.
Therefore you only pay tax on your profits as and when you earn them. This is great for cash flow as it means the provisional tax you pay is in line with those highs and lows.
Your due dates for AIM are generally the same as your GST due dates, so if you paid GST every two months, you will pay provisional at the same time which makes life easy.
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, or just need help managing cash flow, we’ll usually recommend AIM for you.
Here’s an example.
Jenny’s Pies & Fries Limited makes a $6000 profit over from 1 April to 31 May. Based on their AIM return, they have to pay taxes of $1680 on this profit (at 28%). So they process AIM and make this provisional tax payment in June with their GST.
At the end of the year, once the annual accounts are done (and the numbers are finalised) if the amount of provisional tax paid is more than the actual amount, you will get a refund and vice versa.
4. The Ratio Method
The ratio option for provisional tax is a flexible method designed to align your tax payments with your cash flow, making it particularly beneficial for businesses with variable or seasonal incomes. You need to be GST registered to use this option.
Under this option, your provisional tax is calculated as a percentage of your ‘total GST-taxable supplies,’ this basically means revenue that includes GST on (for most businesses it would be the majority of total income from NZ customers). This allows you to pay tax as you earn income.
So in English, basically every 2 months you pay a percentage of all sales inclusive of GST.
For example, if your residual income tax was $10000 tax last year and you sold $500,000 worth of products and services including GST (which would be $434.78 without the GST added in). Then (10,000 / 500,000) x 100 = 2%. So every 2 months you would pay IRD provisional tax on 2% of your income that included GST.
As mentioned earlier, businesses in New Zealand are required to pay their provisional tax in either three or six installments, depending on their circumstances. The key dates and deadlines for these payments are as follows:
For businesses paying three installments (on the Standard or Estimation Method):
For businesses on Accounting Income Method (AIM): If you file 2 or 6-monthly GST returns or you are not registered for GST, you'll file a statement of activity every 2 months.
For businesses on the Ratio (same as AIM)
It's important to note that these deadlines are strictly enforced, and businesses that fail to make their provisional tax payments on time may face penalties and interest charges. Businesses should also be aware that the amount of their provisional tax payments may need to be adjusted throughout the year based on changes in their estimated income or other factors.
If you are unsure of your businesses provisional tax payments or have questions about the payment deadlines, let’s chat. Our small business accounting services and business advisory services are designed to help.
There are several different options available for businesses in New Zealand to pay their provisional tax.:
Regardless of the payment method chosen, it's important for businesses to ensure that they are making their provisional tax payments on time and in the correct amounts. Failure to do so can result in penalties and interest charges, which can have a significant impact on the business's financial well-being.
Managing provisional tax payments can be a challenging task for businesses, particularly those that are new to the process or have variable income streams. However, there are several strategies that businesses can employ to ensure that they are meeting their tax obligations effectively and efficiently:
By following these tips, businesses in New Zealand can effectively manage their provisional tax payments and ensure that they are meeting their tax obligations in a timely and compliant manner. This, in turn, can help to reduce the risk of penalties and interest charges and improve the overall financial health of the business.
While it's possible for businesses to calculate their provisional tax liability on their own, working with an accountant or tax advisor can be a valuable investment. These professionals have the expertise and knowledge to help businesses navigate the complexities of the provisional tax system and ensure that they are meeting their tax obligations in a timely and compliant manner.
One of the key benefits of working with an accountant or tax advisor is that they can help businesses to develop a comprehensive tax planning strategy. This may involve estimating their income for the current tax year, identifying potential deductions and credits, and developing a plan for making their provisional tax payments. By working with a professional, businesses can ensure that they are paying the correct amount of tax and avoiding any penalties or interest charges.
In addition to providing guidance on provisional tax planning, accountants and tax advisors can also assist businesses with other tax-related matters, such as preparing and filing their annual tax returns, managing their payroll and withholding obligations, and advising on tax-efficient business structures and strategies.
Provisional tax is an important consideration for businesses in New Zealand, as it can have a significant impact on cash flow and financial planning. Businesses that fail to pay their provisional tax on time or in the correct amounts may face penalties and interest charges, which can further strain their financial resources.
Provisional tax is not just a regulatory requirement – it's a tool that can help you manage your cash flow, plan for your tax obligations, and ultimately, support the overall growth and success of your business. By staying on top of your provisional tax payments and leveraging the various payment options available, you can optimise your tax strategy and focus on what really matters – running and growing your business.
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. We’re your one stop shop for all your small business accounting services.
For more info on personal provisional tax, read our blog here.
.png)
.png)
.jpg)
.png)
If you find a cheaper all inclusive accounting solution similar to the 'BOM Difference', we will beat it by 10%. In addition, if we haven't made your life as a business owner easier after 3 months, we will donate all subscriptions fees to your favorite NZ charity.
