What you need to know about Provisional Tax
As a small business owner in New Zealand, understanding your tax obligations is key to maintaining financial health and compliance. One obligation you’ll likely encounter is provisional tax. At Affinity Accounting, our accountants are here to help businesses across NZ with the complexities of provisional tax. This breakdown is designed to give you the information you need to make smart decisions, but please don’t hesitate to reach out if you have any questions.
What is Provisional Tax?
Provisional tax is a method of paying income tax throughout the year in instalments, rather than as a lump sum at the end of the financial year. This system helps businesses manage their cash flow more effectively and avoids the burden of a large tax bill.
Who Needs to Pay Provisional Tax?
You need to pay provisional tax if:
Your residual income tax (RIT) from the previous year was more than $5,000.
You expect your RIT for the current year to be more than $5,000.
Residual income tax is the amount of income tax you have to pay after deducting PAYE, withholding tax, and other tax credits.
How is Provisional Tax Calculated?
There are three main methods for calculating provisional tax:
1. Standard Option
This is the most straightforward method, where your provisional tax is based on your previous year's RIT plus 5%. This method is simple but may not accurately reflect your current year's income, especially if your earnings fluctuate.
2. Estimation Option
With this method, you estimate your income for the current year and calculate your provisional tax based on that estimate. This option requires careful forecasting and can be risky if your estimate is significantly off, leading to penalties.
3. GST Ratio Option
If you’re registered for GST on a one-monthly or two-monthly basis, you can use the GST ratio option. This method calculates provisional tax based on a percentage of your GST taxable supplies. It aligns your provisional tax payments with your business's actual performance.
4. Accounting Income Method (AIM) Option
The Accounting Income Method is a flexible option for managing provisional tax, particularly beneficial for small businesses with fluctuating income. With AIM, you pay provisional tax based on your actual profit for the period, calculated through your accounting software, like Xero. This method aligns your tax payments more closely with your business's real-time performance, reducing the risk of underpayment or overpayment. AIM can help improve cash flow management and accuracy of tax obligations, making it a suitable choice for businesses that want to avoid the guesswork associated with traditional provisional tax methods. Consulting with accountants Affinity Accounting can help you determine if AIM is the right fit for your business.
Payment Dates
Provisional tax payments are typically due in three instalments during the year, although some businesses may qualify for six instalments. The standard due dates are:
28th August
15th January
7th May
If you’re using the GST ratio option, your payment dates align with your GST filing dates.
Managing Provisional Tax Payments
Proper planning and cash flow management are crucial when dealing with provisional tax. Here are some tips to help you stay on top of your payments:
Maintain Accurate Records: Keep detailed financial records to help forecast your income and expenses more accurately.
Set Aside Funds: Regularly set aside money for your provisional tax payments to avoid cash flow issues.
Review Estimates: Periodically review and adjust your income estimates to reflect your business's performance accurately.
Seek Professional Advice: Make sure you consult with Affinity Accounting’s team of Wellington accountants, to ensure you’re using the best method and making accurate payments.
Penalties and Interest
If you underpay your provisional tax, you may be subject to penalties and interest. The IRD charges interest on any shortfall in your provisional tax payments, so it's essential to use a trusted accountant so you can make accurate estimates and timely payments.
Need help?
At Affinity Accounting, our team of experienced Wellington accountants is dedicated to helping you manage your provisional tax efficiently. We provide personalised advice and support tailored to your specific business needs. Contact us today to learn more about how we can help you.