Provisional tax in New Zealand can be confusing, especially if you are just starting out. We’re seeing more people who have small businesses, contracting or even rental property owners starting to pay provisional tax so we’ve put together a guide to help you understand more.
What is Provisional Tax?
Provisional tax is income tax you pay in instalments during the year.
Everyone pays income tax if they earn income. Self Employed people, rental property owners and people who earn non-PAYE income need to pay their own income tax.
You pay provisional tax if your tax bill for the last tax year is more than $5,000 (previously $2,500).
Your first year in business:
When you first go into business in New Zealand, you don’t actually have to hand over any income tax to IRD for quite some time (unless you are going to be earning over $208K in profit for your first year – then different rules apply).
If your first financial year will end at the 31 March 2022 – then your financial accounts and returns are prepared and any income tax payable for that year is due to Inland Revenue by the 7 April 2023 (the following year or 7 February if you don’t have a tax agent) – so you can effectively get up to 24 months trading before you have to pay your first years tax to IRD. This tax is called Terminal Tax.
However in your second year – eg from 1 April 2022 to 31 March 2023 – you may need to pay provisional tax. If your first terminal tax to pay is over $5,000 then provisional tax is triggered – this means you have to pay income tax for your second year of business in the second year – not a year later. It’s like paying as you go rather than paying in arrears.
How is provisional tax calculated?
There are 3 different methods to calculate your provisional tax. The standard method is the most common and is the default option:
The standard option:
Inland Revenue take the terminal tax figure from the last year and add 5% to it – this is your provisional tax amount to pay – and is usually due in 3 instalments during the year.
If you are a Sole Trader, and file your GST returns each 6 months, you will pay in 2 instalments per year which aligns with your GST payment dates.
When your financial accounts and tax returns are prepared – all that provisional tax you’ve paid will be sitting as a credit against your name to offset your final tax bill for the year. Any overpayment will be refunded to you, any underpayment will become your terminal tax and will be payable by 7 April 2022.
Untaxed income 2021-2022 Financial Year: $40,000
2021-2022 Financial Year total Income Tax Bill = $6,020
Because the tax bill is over $5,000 provisional tax is due for the next year
Provisional Tax for 2023 Financial Year:
$6,020 + 5% = $6,321 for the year
Split into 3 instalments:
$2,107 – due 28 August 2022
$2,107 – due 15 January 2023
$2,107 – due 7 May 2023
The AIM and ratio options:
Both options are based on your GST Results, rather than your previous year’s income tax returns. This can involve quite a lot of extra work throughout the year but more accurate amounts to pay, based on the year-to-date activity. The AIM option requires you to have an AIM-capable accounting software.
Provisional Tax can be a little confusing initially, so if you’re having problems understanding or you would like someone to look after this for you, please contact us.
About Kiwitax – Award winning business improvement, tax and accounting service
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