Provisional Tax – avoiding the pitfalls
If you are liable for provisional tax and you don’t pay, underpay, or pay the tax late, you may be liable for both penalties and use of money interest (UOMI).
There are ways to minimise your exposure to these, and to manage provisional tax to best suit your business.
So, what is provisional tax?
Provisional tax is income tax paid in instalments during the year to avoid a large lump sum payment at year end.
It is calculated using the prior year’s tax. At the end of the financial year, a wash up calculation is performed, with any overpayment or underpayment resulting in a tax refund or additional tax to pay. We’ll take you through some of these calculations shortly.
If your tax for the prior year is $5,000 or less, you do not have to pay provisional tax for the current year.
Most taxpayers pay provisional tax in three instalments, with the last instalment due approximately one month after your balance date. If you are registered for six monthly GST, you will only have two instalments.
What are the options for calculating provisional tax?
The standard option is based on your previous year’s tax plus a 5% uplift. This method is commonly used where your income is steady or increases from year to year.
- If your tax for the year ends up being less than $60,000 you will not be charged any UOMI unless an amount remains unpaid after your terminal tax date. We refer to this as the “safe harbour” rule. Late payment penalties will however apply to any late payments.
- If your tax ends up being $60,000 or more, you fall outside of the rule and provided you pay the first two instalments of provisional tax on time, UOMI will only be charged from the third instalment date.
If you know your income is likely to decrease over the next year, you should consider estimating your taxes downwards in line with expected income.
Care needs to be taken when estimating as any shortfall in tax will result in UOMI being payable from the first instalment date.
The Accounting Income Method (AIM) and GST Ratio Option are targeted toward a select number of taxpayers whose income is either seasonal or irregular and wish to pay provisional tax each GST period according to how their income is tracking.
Certain criteria apply to each method and the completion of the returns can be complex. If you think these methods may be appropriate to your business, please get in touch with your advisor.
How to avoid UOMI and late payment penalties
The cost of missing a tax payment can hurt, particularly with hefty late payment penalties and UOMI designed to deter late payers.
So, here’s are a few simple tips and tricks:
- Pay your taxes on time. Being just one day late with any of your Provisional Tax payments can expose you to penalties and/or UOMI. When your tax notice arrives, set the payment up and pre-date if you need to.
- If you do miss a tax payment, contact your advisor immediately. By paying the missed tax through an authorised tax pooling intermediary, you can eliminate the late payment penalties and reduce the impact of UOMI significantly. Your advisor will arrange this for you.
- If you are unable to make payment in full, contact your advisor prior to the due date to make an instalment arrangement with either Inland Revenue or via a tax pooling intermediary. Inland Revenue are far more lenient with penalties when you enter an arrangement before the due date.
- If your tax is likely to be $60,000 or more, liaise with your advisor to ensure they are aware of your income, particularly where your advisor does not have regular access to your records. If funds allow, consider topping up your third instalment of provisional tax.
- Review and update any provisional tax estimates you make throughout the year. If income looks to be higher than your initial estimate, increase your tax payments accordingly.
- If you are a new provisional taxpayer and you expect your tax to be $60,000 or more, pay voluntary tax from the first instalment date.
The key here is to communicate with your advisor, sooner than later and be open about your tax understanding. By making a quick five-minute phone call you can save a bundle of unnecessary cost and help keep you on top of your tax payments.
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