Disclaimer: NZ tax specific article ahead – it may not apply to you if you are not an NZ tax resident.
One of the biggest shockers for my clients at the end of a tax year is finding a giant red number on their online account saying that they still owe the IRD money EVEN THOUGH they’ve just paid the tax for the year.
Unfortunately – this is a minor design/communication issue that IRD is working on at the moment. If you have paid your taxes for the year, then chances are you don’t owe any tax to IRD… yet.
The big red numbers you see on the MyIR screen is in fact, something known as ‘Provisional Tax’.
I have covered provisional tax before in an article talking about COVID-19 Tax Reliefs – however I feel like it deserves an article all of its own, simply because it causes so much heartache and confusion among small business owners.
So without further ado, let’s get into it!
What is provisional tax?
Simply put, provisional tax is tax that you pay ahead of time. Under the new revised tax laws (thanks COVID-19!), if you have tax payable of at least $5,000 at the end of the tax year, IRD will estimate provisional tax for you to pay in the next tax year. The estimated tax to pay is always calculated at a 5% uplift.
As always, let’s illustrate it with an example:
Jenny has a dog-grooming business which received an income tax bill of $5,200 for the year ending 31 March 2020. This means that for the 2021 financial year, she will have provisional tax of $5,250 to pay ($5,200 uplifted at 5%).
So you see, if you have tax to pay above the $5,000 threshold, IRD will automatically calculate the provisional tax you have to pay in the following year. It’s just a really smart (or sneaky – depending on how you look at it) way for them to make sure you pay your taxes BEFORE they are due.
When should I pay provisional taxes?
Generally speaking, provisional taxes are always paid in three equal payments throughout the tax year. If you have a 31 March year end date (like most Kiwi businesses, unless you are a farmer, in which case this might differ) the provisional tax due dates are:
28 August
15 Jan
7 May
So let’s go back to the example of Jenny:
Jenny now has provisional tax of $5,250 to pay in the 2021 financial year. She now has to make three equal instalments of $1,750 throughout the year. Her payments will be due on a schedule as follows:
| 28 August 2020 | $1,750 |
| 15 Jan 2021 | $1,750 |
| 7 May 2021 | $1,750 |
Failure to pay provisional taxes by their due dates will result in penalties and interests being charged! So make sure that you keep note of your provisional tax dates and pay them on time!
But what if I’m making less money this year? I can’t be paying that much in taxes!
Fear not!
If, by the end of the financial year – it turns out that you’ve made less profit than what was expected, you will get a refund on whatever excess amounts you have paid through provisional tax.
Furthermore, if within the first few months of the financial year, you realise that business is going downhill (like COVID-19 lockdown happening in April 2020!) you can always re-estimate the provisional tax in your My IR account:
So this way you can re-estimate your provisional tax to a level which is better suited to your current business projections.
Provisional tax is soooo complicated! My head hurts!
Welp, ok. I hear you – provisional tax is a bit hard to swallow. Fortunately, NZ IRD has come up with a (relatively) new way of paying taxes called the Accounting Income Method! Or AIM!
Under AIM – you don’t have to worry about paying provisional taxes on time as income tax is automatically calculated the same time as your GST returns. And you basically pay taxes as you go! Easy!
Bear in mind that if you want to jump on the AIM method you will need to have an accounting software that supports it!
AIM deserves an entirely different article all itself – so we’ll cover that in the next article!
In the meantime,
Stay on top of your taxes and
Stay positive!