The IRD introduced provisional tax to help individuals and organisations manage their tax obligations throughout the year rather than having to pay a lump sum at the end of the tax year. The amount you must pay, and when you need to pay, varies from person to person and business to business.
To ensure you’re following the appropriate rules, always work alongside your trusted accountant.
Who has to pay Provisional Tax?
In New Zealand, you have to pay tax on the income you earn. This applies to individuals, self-employed people, sole traders, businesses, and organisations.
If your last income tax bill (also called Residual Income Tax or RIT) was more than $5,000, it is more than likely that you will need to pay provisional tax for the following year. This means paying progressively in advance of your earnings, calculated using the previous year’s totals plus 5%.
To illustrate how this works, the IRD gives this example 1.
Untaxed 2021-22 tax year income $35,000
Tax on this income is calculated as follows:
Income up to $14,000 @ 10.5% $1,470
Income $14,001 – $48,000 @ 17.5% $3,675
Total 2021-22 tax year RIT $5,145
Because the RIT of $5,145 is more than $5,000, provisional tax is due in the following income year.
Using the above example, the provisional tax calculated based on a standard 5% uplift would amount to $5,402.25 ($5,145 plus 5%) payable in three instalments as below:
28 Aug 2022 – 1st provisional tax instalment $1,800.75
15 January 2023 – 2nd provisional tax instalment $1,800.75
7 May 2023 – 3rd provisional tax instalment $1,800.75
Arguably, the system is not flawless. Provisional tax is not an exact science since it is based on estimates and, especially as we’ve seen in recent times, no-one can predict what the next financial year has in store.
However, it should help with cashflow and negate the undesirable scenario of suddenly having to find the money for an unexpected income tax bill at the end of the year. Plus, of course, if it turns out that you’ve overpaid your provisional tax, you’re entitled to a refund. (The reverse is also true; you’ll have to make up any shortfall.)
How do I pay Provisional Tax?
Provisional tax is payable by instalment throughout the year.
For a new business or someone paying provisional tax for the first time, the first payment can be the most challenging, as it has to be paid at the same time as your income tax for the previous year.
There are a couple of ways that could help ease the stress. For example, if this is your first year of being self-employed or a partner in a partnership, you may be entitled to an “early payment discount” on your first year’s income tax. This is designed to act as an incentive for you to pay your tax early and relieve some of the financial strain before you have to pay provisional tax for the first time.
What other factors affect Provisional Tax?
Tax rules and calculations can be complicated – otherwise, everyone would happily manage their own tax affairs without any hiccups or repercussions!
When reading about how to pay provisional tax, you might come across terms like “the standard option”, “the ratio option”, and “the estimation option”. And the number of provisional tax payment instalments can vary between two and 12.
The IRD’s aim with provisional tax is to help income taxpayers “spread the load” and avoid a large end-of-year bill, but there are rules to follow and options to weigh up to ensure you remain compliant with current regulations.
1 Inland Revenue Te Tari Taake IR316 2022
About Pathfinder Solutions
At Pathfinder Solutions, our chartered accountants understand that running a business can be hard. The last thing you need is an unexpected tax bill or penalties and fines for inadvertently not meeting your tax requirements.
Sometimes things that look complicated on paper are more easily explained through a conversation. So, please talk to us! Together we’ll put the processes in place and regularly review them to help you stay on top of all your IRD obligations, including provisional tax.