PROVISIONAL TAX- WHAT IS IT AND HOW DOES IT WORK

 

Provisional  Tax is tax paid as you go for people in business.   It is not a separate tax.   When you fill in your Income Tax Return to calculate your end-of-year tax bill, you deduct the provisional tax you have paid during the year, so the end result is that you will not pay tax twice.

 

Generally you pay Provisional Tax in a particular year if in the previous income year your Residual Income Tax (which is the income tax that is calculated that you have to pay after deducting rebates you can claim and also all tax paid during that year except for provisional tax) was $2,500 or more.

 

You are, however, liable for Provisional Tax in the first year of business in the following circumstances:

If you are an individual and you stop receiving income from employment and begin to derive gross income from a business, and your residual income tax for the past four years was less than $2,500 per year, and your residual income tax for the current year exceeds $30,000.
You are a non-individual (e.g. a company) who commenced business during the year and have not been deriving business income in the previous four years and your Residual Income Tax calculated at the end of the year is $2,500 or more.

 

There are two options for working out Provisional Tax payable:

Standard Option-  under this option the Provisional Tax to pay is the previous year Residual Income Tax plus 5%.   If in the Income year you pay the Provisional Tax it is subsequently found that you have underpaid the Provisional Tax in comparison to your calculated Residual Income tax liability you are not charged penalties (unless your residual income tax turns out to be $30,000 or more), and if was too much IRD will not pay you interest for this.
Estimation Option-   under this option you can estimate your Provisional Tax if you believe it will be different than the previous year Residual Income Tax plus 5%.   If  it is subsequently found that you have underpaid the Provisional Tax in comparison to your calculated Residual Income Tax liability for the year you will be charged interest, and if you have you have overpaid IRD will pay you some interest for doing so.

 

Once you make an estimate, you cannot change to the standard option for that year.   You can re-estimate any number of times up to your third instalment date, when your last estimate becomes final

 

Most businesses tend to select the Standard Option, unless they believe the following year profit will be significantly different.

 

If you donít believe your Residual Income Tax in the following year will be $2,500 or more, even though you  paid Provisional Tax in the current year, you can choose the Estimation Option and estimate Nil.  If this turns out to be the case you will not be liable for interest, but if you were liable to pay Provisional Tax you will be charged interest by IRD.

 

Provisional Tax is payable in three instalments, on the 7th day of the 4th, 8th and 12th  calender months after the previous year balance date.   For example if you have a 31 March balance date, Provisional Tax payments are due on 7 July, 7 November and 7 March.

 

If you are registered with a tax agent and you were not liable to pay Provisional Tax in the previous income year but are liable in this income year you can escape paying in the three instalments if your Income Tax Return for the previous year has not been filed in time for an Instalment, but instead you must pay the full liable amount but in two instalments (7 November and 7 March) or in one instalment (7 March) after the date the Income Tax Return is filed.

 

If your Provisional Tax instalments are paid late or are short paid, you incur penalty an interest charges in relation to the late or under payments.

 

If the Provisional Tax paid during an income year is more than the Residual Income Tax calculation at the end of the income year, you will get an income tax refund fror the difference.   If it is less, you will have to pay the difference to IRD.

 

Many businesses have a free year in the first year from paying income tax (due to the fact that they donít have to pay income tax until their first year Income Tax Return is processed) , but then find that they have to pay two lots of income tax in their second year of business (being the tax calculated for their first year plus Provisional Tax for the second year).   It is this factor which causes a number of businesses to fail in the second year due to the fact that the business has not been budgeting and putting money aside in the first year.   The IRD will accept voluntary payments in the first year even though they are technically due then, and this is an option that businesses should consider if the owners believe that the amount will not be able to be saved otherwise.

 

Some taxpayers are slow in filing returns each year, and due to this are not sure exactly what should be paid in Provisional Tax each instalment.   In this instance, if it is the belief that Provisional Tax will be payable as it is expected that Residual  Income Tax will be more than $2,500 in that income year,  Provisional Tax instalments should still be paid on due dates based on the previous year instalments plus 10% to escape or minimise penalties.

 

 

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