Provisional tax simply refers to a method of meeting your tax obligations by paying it at specified payment dates in advance, rather than in one lump sum at the end of your tax year. However, it is not as simple as just putting an arbitrary amount aside and paying IRD every now and then when you remember. There are some important rules surrounding it that your Leech & Partners manager can help you with.
Establishing the basics
Paying provisional tax is a requirement for any individual, company or trust that has paid more than $2,500 in residual terminal tax (RIT) in the previous year.
The system estimates the tax payer’s annual tax obligation and this is paid in three instalments in order to spread the payments and avoid any nasty surprise at year end. For March balance dates (most common), provisional tax payment dates are August, January and May. The third payment in May is after the end of the financial year and this enables the taxpayer to get a better idea of the final tax obligation for the year. Different balance dates will have different provisional tax payment dates.
How do you know what to pay?
To ascertain what you need to pay with some degree of accuracy, a few different methods of calculation can be used. The two most popular options are:
- The standard option: This is a relatively straight-forward calculation and the most used option. It simply adds 5% to your last year’s RIT. This is suitable for businesses with a steady income or one that increases from year to year. With a standard balance date, you will pay three instalments during the year. A six-monthly GST filer will pay two instalments.
- The estimation option: This is useful if you are certain your income may differ over the next year. It is very easy to calculate, and simply involves adding all your expected income for the next year, calculating the tax on it and deducting any PAYE or credits you may be eligible for. The important thing to remember is that your estimate needs to be realistic. Underestimating income could result in interest and penalties. This option of paying provisional tax is also paid in three instalments per year, unless you’re a six-monthly GST filer, in which case you will pay two instalments.
The tax laws are complex by their very nature, and unfortunately, can result in over or underpayments if you try and go it alone. Interest on inaccurate payments works two ways. If you overpay, IRD owes you interest which is a welcome surprise; however, underpaying your tax results in use-of-money- interest (UOMI) which can be substantial and accrues until the balance is zeroed.
Tax intermediaries can be helpful as we can purchase tax from them (on your behalf) after provisional tax due dates have passed, and then have it paid to Inland Revenue on the specified provisional tax payment dates. This helps you to avoid the high-interest and penalties from IRD while still meeting all requirements. We can organise those payments for you.
Please do not hesitate to get in touch if you need us to walk you through the provisional tax process.