What the heck is provisional tax?
Provisional tax is the tax you pay throughout the financial year on your business income.
It’s designed to match the timing of your tax payments to the timing of your business earnings.
It’s also designed to reduce the risk of not being able to pay your tax. If all your tax fell due at the end of the year, it would be harder to pay as it’s going to be one big sum.
It makes sense that if it’s split up evenly through the year, closer to the time you earn the income that the tax is paid on, it will be easier to pay.
Who are provisional tax payers? Only people and entities that have been in business for more than one year
You have to have earned business income in order to be a provisional tax payer.
The current threshold is $5,000 of untaxed business income.
Now, that means that if you’re in your first year of business, you wont be a provisional tax payer.
Why? Because Inland Revenue will only know that you earned that income at the end of your first financial year when you file your first tax return.
Once you’ve filed your first tax return, the tax will be calculated on the business income you made during the year.
The tax on that income will be due either in April the following year, or July if you don’t have an accountant.
On top of that end of year tax to pay, if the tax is over $5,000, you’ll become a provisional tax payer for the next financial year.
Provisional tax is paid through the year in three equal instalments (usually!).
Ok, so I pay provisional tax, but when must I pay it? Usually in August, January, and May
You’ve filed your first tax return for the financial year ended in March (in New Zealand March is the standard end of financial year), you must now pay your first provisional tax instalment in August of the same year.
That’s a bit of a head scratcher because you already have a tax bill for the previous financial year.
I agree. That’s why you need to file your tax return early to get on top of this first payment that’s due.
So, how much do I pay? Take last years tax bill, add 5% and divide by three…
I’m not even joking.
That’s the formula.
So, if your tax bill was $5,000, your first provisional tax instalment would be $1,750.
If your tax bill was $30k, your first instalment would be $10,500.
Your second instalment due in January and your third instalment due in May will be for the same amount.
Now, for those who file there GST returns on a six-monthly basis, you will pay your provisional tax two times a year.
Your GST and provisional tax due dates will be the same. This is usually the 28th of October, and the 28th of April.
I just spoke with my accountant, and they say I need to make a bigger payment of the 7th of May...
Right, well if you have been growing very well and you are paying more than $60k per annum in income tax, then you must pay all of your tax for the year by this date.
What the hell, why?
Again, it’s to reduce the chances of you having toooooo much to pay and not being able to pay it.
So, if you’re earning that much and have so much tax to pay, Inland Revenue Reckons you should know how much your final tax bill for the year will be, and therefore you must pay it by May.
Remember, the financial year ends in March, so by the end of March you’ll have all your numbers figured out and be able to determine your tax bill, to be paid in May.
You’ve got to be very careful here though..
Because if in the previous financial year you paid less than $60k in tax, you’ll be surprised when your accountant tells you you must pay it in May (usually with very little notice).
And also because you will have paid your final tax bill for the previous financial year in April. So, you’ll get hit twice IN THE FACE by the taxman in a super short space of time.
Provisional tax explained in 5 bullet points.
Ryan, I paid my provisional tax but I was charged penalties and interest? What? Yup, pretty common.
This happens if you paid late or didn’t pay the exact right amount.
Inland Revenue will then think ‘Oh, they didn’t pay their provisional tax properly, they should be penalised.’
And penalised you will be. If you pay late, they’ll charge you a 5% late payment penalty and 10.91% interest on the unpaid amount. That’s fricken high.
Also, for any shortfall in tax for the year, it will all be due in May, rather than April the following year. So, you’ll literally have a year less to pay your final tax bill. That will hurt.
Now, if you did accidentally miss the due date by one day or you underpaid by one-dollar, Inland Revenue are normally pretty good with this and will remove any penalties and interest, but you usually need to speak to them about it.
So, pay your provisional tax on time and in full and you will avoid a painful headache.
How do I reduce my provisional tax? You go onto PAYE…
Provisional tax is based off of UNTAXED business income. So if you minimise your untaxed business income, you will minimise your provisional tax.
You can do this by paying yourself and fellow directors or shareholders, a PAYE salary through the year.
Just like you pay your staff, you will also now be included in the regular payroll.
You’ll no longer take drawings from the business bank account, and you will live off of your salary.
It’s actually not complicated to set up. I wrote an article on how to do it here.
At the end of the day, you’ll still be paying tax through the year, but it will be easier to manage. You’ll reduce your provisional tax AND your end of year tax.
BOOM.