Understanding What is Provisional Tax in NZ

Understanding Provisional Tax in NZ is essential for taxpayers to understand their tax obligations in New Zealand, including how provisional tax works and when payments are due. Failing to meet these obligations can result in penalties and interest charges.

About Provisional Tax in NZ

Provisional tax in NZ is not some mysterious extra tax. Provisional tax is simply a way to manage your income tax throughout the year. Instead of facing a hefty lump sum at year-end, IRD require you pay tax in smaller instalments and in advance. Think of it as spreading your tax ‘load.’

Who needs to Pay Provisional Tax in NZ?

If your residual income tax (RIT) from your last tax return exceeds $5,000, you will need to pay provisional tax. Provisional tax is not just for businesses. It could apply to any type of taxpayer whether a Company, Individual, Trust or Estate.

Situations that trigger provisional tax may include:

• Business or rental income.
• Incorrect use of tax codes or rates for PAYE, interest, or PIE income
• Overseas Share Investments not taxed at source. See our blog: NZ Tax Implications Overseas Share Investments
• Lump sum payments without sufficient tax deducted.
• Employee share scheme income without tax deducted.
• Property sales subject to the bright-line property rule.
• Even bullion and crypto currency income can come into play! See our blog: IRD Compliance Crackdown: What NZ Businesses Need to Know

These due dates can vary slightly to avoid public holidays and weekends. If you use different methods like the ratio option or AIM (Accounting Income Method), the due dates differ.

What is residual income tax (RIT)?

Residual Income Tax (RIT) refers to the amount of income tax that remains payable after accounting for all tax credits (like PAYE and withholding tax) but before deducting any provisional tax already paid.

When is provisional tax due in NZ?

Provisional tax in NZ is due in three instalments throughout the year. If you have a standard balance date of 31 March, here are the due dates:

1. First Instalment: 28 August
2. Second Instalment: 15 January
3. Third Instalment: 7 May

You would only have two instalments of provisional tax due if you are registered for GST and file these returns on a six-monthly basis. In this case, your provisional tax payments align with your GST payment dates. The due dates for these two instalments are:

1. First Instalment: 28 October
2. Second Instalment: 7 May

This setup helps streamline your tax payments by combining them with your GST obligations.

Calculating Provisional Tax in NZ.

As mentioned above, if your residual income tax (RIT) from your last tax return exceeds $5,000, you will need to pay provisional tax. There are three ways provisional tax may be calculated.

1. Standard Option: This method uses your previous year’s residual income tax (RIT) plus 5%. It is straightforward and works well if your income is steady or increasing.
2. Estimation Option: Here, you estimate your income for the current year and calculate the tax based on that estimate. This method is useful if your income fluctuates significantly. However, if you get it wrong and estimate short, then Inland Revenue will impose interest.
3. Ratio Option: This method is available if you are registered for GST and file returns monthly or two-monthly. It calculates provisional tax based on a percentage of your GST taxable supplies.

Tell me more about the Standard Uplift Method.

This is the most common method. While the standard uplift is 5% on last year’s RIT, it can involve a 10% uplift in certain situations. Here is how it works:

Previous Year’s Return Filed Late:

If you have not filed your previous year’s tax return by the first provisional tax instalment date, your provisional tax for the first instalment will be based on your residual income tax (RIT) from two years ago, plus 10%.

Example: Gerard’s RIT is $6,000 for 2023 and he pays provisional tax three times a year. He has not filed his 2024 tax return before 28/8/2024 (which is the first provisional tax date for 2025). IRD will expect a payment of $2,200 for the first of three provisional payments, due 28/8/2024. ($6,000 + 10% / 3 instalments).

Subsequent Instalments:

If you file your previous year’s return after the first instalment but before the second, the first instalment will still be based on the RIT from two years ago plus 10%. The second and third instalments will then be based on the previous year’s RIT plus 5%.

Example: Gerard’s RIT is $6,000 for 2023. He has already made a payment of $2,200 on the 28/08/2024 (see the above example).

He files his 2024 tax return before 15/01/2025 which is the second provisional tax date for 2025. His RIT is $8,000 for 2024. IRD expect 2/3rds of his provisional tax to be paid by 15/01/2025. His payment for 15/01/2025 will therefore be $3,200 ($8,000 * 5% * 2/3rds = $5,500 – $2,200 paid 28/8/2024).

All Instalments Filed Late:

If you file your previous year’s return after the second provisional tax date, the first and second instalments will be based on the RIT from two years ago plus 10%. The final instalment will be based on the balance needed to get to the previous year’s RIT plus 5%.

Example: Gerard’s accountant files his 2024 return in February 2025 (which is before the due date 31/3/2025 as he has extension of time privileges). His RIT is $8,000 for 2024. IRD therefore expect $8,400 in total provisional tax on account of 2025 ($8,000 RIT + 5% uplift).

IRD will expect a payment of $4,000 for the third provisional payment 7/5/2025. This is calculated as follows: Total provisional due is $8,000 2023 RIT * 5% = $8,400. Less $4,400 already paid – $2,200 paid 28/7/2024 and $2,200 paid 15/1/2025 (these two payments being based on 2023 RIT +10%).

This method ensures that you are making provisional tax payments even if your most recent tax return has not been filed before the provisional tax is due for the following year.

What if you miss your provisional tax payment?

If you miss a payment, you must pay the remaining balance or risk late payment penalties (LPP) and interest accruing on what you owe.

Late payment penalties and interest on missed provisional tax.

Penalties and interest on missed or underpaid tax are charged as follows:

• one percent the day after the payment was due.
• an additional four percent if the tax amount (including LPP and accrued UOMI) remains unpaid after seven days.
• UOMI may be charged from the day after the payment was due – UOMI will be charged daily until you have paid your total tax amount, including late payment penalties and any accrued interest.

However special interest rules under the Safe Harbour Provision.

Standard uplift and RIT under $60,000.

Here, you do not have to worry about incurring IR interest if the tax you have paid during the year is less than your actual RIT total. This is because you fall under what is known as the Safe Harbour Provision. Any final balance to settle your tax bill will be due by your terminal tax date. IR interest will only apply from your terminal tax date if you do not pay your balance by then. Note, late payment penalties will still apply.

RIT $60,000 or more.

The rules work slightly differently if the actual RIT is $60,000 or more. In that situation, if you have paid all your instalments on time and in full, you will incur IR interest on the remaining balance until you have paid in full. IR interest is calculated from your final provisional tax instalment date for that year.

Estimate method.

If you choose to opt out of the safe harbour by estimating your provisional tax, you will be subject to use of money interest on any underpayment of provisional tax from your first instalment date.

Ratio method.

If you used the GST ratio option to determine your provisional tax payments for the whole year you will be safe harboured from use of money interest if your payments fall short of the year-end liability.

What happens if I cannot make a provisional tax payment?

If you are required to pay provisional but the safe harbour provisions (mentioned above), do not apply then tax pooling may be suitable as a tool to reduce interest and penalties. It can also be used to extend paying your terminal tax.

Tax pooling.

Tax pooling allows you to finance your upcoming provisional tax payments and defer upcoming provisional tax payments to a later date without incurring Inland Revenue late payment penalties or use of money interest.

You pay an authorised intermediary such as Tax Management NZ (TMNZ) and it arranges the upcoming provisional tax payment on your behalf. This is held in an Inland Revenue account, overseen by an independent trustee. When you repay the tax, the independent trustee instructs Inland Revenue to transfer the tax into your Inland Revenue account. Inland Revenue treats the tax as paid on time once the transfer is processed.

Provisional tax and your first year of trading.

You are required to pay tax on the income you earn in your first year of business. However, Inland Revenue does not expect you to make tax payments until after you have completed your first tax year and filed your first tax return.

For example, if your first financial year ends on 31 March 2024, your terminal income tax will be due on 7 April 2025 if you are using an accountant like Business Like NZ Ltd. Otherwise it is due on 7 February 2025 if you are doing your own taxes.

Does this mean I pay double tax in my second year?

In the second year of trading, the concept of “double tax” often comes up because you might feel like you are paying tax twice. Here is why:

First-Year Tax: In your first year of business, you are not obliged to pay provisional tax. Instead, you pay your income tax after the end of the financial year when you file your tax return.

Second-Year Provisional Tax: In your second year, you start paying provisional tax for the current year based on your previous year’s income. This means you are paying tax for the current year while also settling the tax for your first year.

So, it can feel like you are paying double because you are managing both the previous year’s terminal tax and the current year’s provisional tax simultaneously. However, it is not actually double taxation; it is just the timing of the payments that creates this impression.

Should I consider voluntary provisional tax payments?

In your first year of trading or if you are having a much better year than the previous tax year, this is a good option if you want some piece of mind from being up to date with your tax obligations. Alternatively, you are disciplined with savings you can keep tax aside in a dedicated bank account.

It may be to your advantage to make voluntary provisional tax payments. This will help reduce use of money interest charges on any known tax shortfalls when your total tax is over $60,000.

Navigating Provisional Tax in NZ.

The tax regime can be hard to understand. If you are liable to pay provisional tax in NZ, there are various options. Some suit better than others. It is important to have a tax plan in place, so you meet your obligations without incurring additional penalties or interest or squeezing your business’ cashflow.

To navigate tax in New Zealand effectively, it is recommended you seek professional advice from an accountant to ensure compliance with tax laws and regulations. If you would like to learn more about other taxes, see our articles:

What Is Withholding Tax?

Overseas Share Investments Tax Implications

Understanding NZ Marginal Tax Rates: A Simple Guide

Business Like NZ has been providing professional yet affordable tax, accounting and business advice to the Auckland region and beyond for years! If you would like to discuss your tax obligations with us, please contact us at the office.