(AIM provisional tax – 4 minute read)
Hi there accounting fans!
Following on from the previous article talking about provisional tax, let’s focus on the different methods for calculating provisional tax.
In the previous article, we talked about the three methods of calculation:
- Standard
- Estimation
- AIM (Accounting Income Method)
It’s important to preface that Estimation is a no-no in most cases. You only use it in specific circumstances (outlined in the previous article). So that leaves the average tax paying business owner in Aotearoa NZ two choices: Standard or AIM.
Please note that you ONLY get flagged for provisional tax if your residual income tax was more than $5,000 in the previous tax year.
Standard provisional tax
Standard calculation is very simple. You take your residual income tax from the previous year (your tax remaining after taking away tax credits from PAYE/other deductions) and multiply it by 1.05 – the 5% uplift.
If you made $10,000 worth of residual income tax, then in the next tax year you have to pay $10,500 worth of provisional tax ($10,000 X 1.05). IRD divides this amount into three equal portions over the next year or so. Instalments are payable in August of this year, January next year and May next year.
Why use the standard method?
Because it’s easy to understand. With the standard method, you get a little calendar on your MyIR screen that reminds you when payment is due:
So long as you make the payments, you are sweet with the IRD!
Knowing exactly how much to pay and by when also means you can plan your cash flow ahead better.
Please note that provisional tax only offers an estimate of your ACTUAL tax liability at the end of the financial year. Don’t be surprised if you have to top up more than what you’ve already paid at the end of the year due to windfall profits! Conversely, if you made bigger losses than expected, you can expect to receive provisional tax overpaid as a refund.
What happens if I miss my payments?
Prior to the financial year 2023 (1 April 2022 to 31 March 2023) you’d get charged interest on outstanding amounts if you missed any of the due dates.
From 1 April 2022 (financial year 2023) onwards, if you are using the safe harbour option – you won’t get charged interest on missing payments. SO LONG AS you pay your tax owed in full by the end of year tax due date. Talk to your accountant for more details on this!
Why NOT use the standard method?
Because it doesn’t make sense.
I mean, SURE you’re going to make exactly 5% more profit next year than you did this year *Heavy sarcasm*. But let’s face it, no one knows for certain how much they will make in the new year.
If you end up making more profit (it’s not uncommon for new businesses to experience 100% or even 200% growth in the first few years) you have grossly underpaid your provisional tax. At tax year’s end, you’ll have a even fatter tax bill to top up your provisional payments. If you’re not careful, you could have blown through your cash before tax time and then you’ll be in a tough spot!
If you’re making a loss, you’re going to struggle to find the money to meet your instalments by their due date (a situation that has been remedied thanks to the new safe harbour options).
Let’s take a look at the other option:
AIM Provisional tax
The idea behind AIM (Accounting Income Method) is easy. Only pay taxes on the income you’ve ACTUALLY made. In practice though, it can be complicated.
AIM returns are only available to businesses making turnover of less than $5 million a year. If you’re making more than this, AIM is not available to you.
AIM returns are filed every two months and is calculated based on the profit and loss report generated by your accounting software for your business. Commonly used accounting software in NZ (like MYOB and Xero) have support for AIM. It’s best to check with your software provider if they can calculate AIM.
You then pay taxes based on the estimated profit generated by your business over those two months. If you make a loss, this sits as a credit in your provisional tax account that can be used to offset any future profits generated by your business in the coming months. You can check our previous article for more details on how this works.
It’s important to note that AIM calculates profit on an ongoing basis. This means that any year end adjustments that you or your accountant makes (like depreciation, home office expenses, mileage claims, subsidy recognitions) are not included in the provisional tax returns. Your actual tax liability at the end of the year could still be higher/lower than what was actually paid in provisional tax.
Why use AIM provisional tax?
Because it makes sense.
Why pay taxes when you’re not making profit? Right?
Also, if you’re making lots of profit, it’s only fair that you pay more taxes.
AIM makes a lot of sense for businesses where income is cyclical. In the recent pandemic lockdowns, hospitality businesses could have benefited a lot from switching to AIM, instead of having to cough up money to meet their standard provisional tax instalments. The idea of paying taxes on what you’re ACTUALLY making is very appealing to most businesses.
Compared to the standard method, there is less discrepancy between the amount you’ve paid for AIM provisional tax and your actual year end tax. You don’t have to worry about a fat tax bill at the end of the year (since it’s been broken down into two-monthly chunks throughout the year).
Why NOT use AIM provisional tax?
Because it’s hard to understand.
If you don’t have an accountant it can be challenging to set up your software for AIM. An AIM return is filed every two months (on top of your GST return, if you’re GST registered). This can create additional admin headaches for you. Here’s what the average AIM form looks like in MYOB essentials:
…And that’s like only 20% of the form. I hope you know how to make Manual tax adjustments.
On top of its complexity, AIM also requires more frequent payments – once every two months to be precise. This can impact your cash flow if you’re not careful. It is a method that demands you constantly put money away for taxes. Which is not a problem if you are using the Pay Yourself! method. But can be an issue if you’re not disciplined in saving for taxes.
AIM provisional tax or Standard Provisional tax?
To keep it simple:
If your yearly income is predictable (you are a contractor or business growth has plateaued) – Standard provisional tax is the way to go. It’s clean, simple and predictable (even if somewhat impractical). So long as you have enough money to pay for taxes by their due date, you are good to go!
If your business is still growing and/or cyclical/variable in nature, AIM provisional tax is the better option. You only pay taxes on what you’ve earned. If you’re engaging in a period of expensive growth spending, you won’t get charged a lot for taxes for that period. Some contractors like AIM as well since tax is deducted more frequently. This makes them feel like they have the predictability of PAYE-style tax deductions but with the tax flexibility that comes with being self employed. It’s worth noting that due to its initial complexity, AIM is best done with an accountant helping you set it up. If you are using Xero, it’s impossible to run an AIM return without an accountant (or Xero partner).
You can switch to AIM mid-year from standard, but I’m not entirely sure if you can switch back to standard from AIM mid-year… so that’s something worth taking into consideration as well.
Happy new tax year everyone! Make sure you stay on top of your provisional taxes and may fortune (and not the IRD) always knock on your door!
Stay positive!