Provisional Tax helps you to spread the load

Most of us dislike Provisional Tax because its time consuming and complicated. However, with some good planning and advice, it may not be such a hard task.

Provisional Tax is not a separate tax. It is income tax that you pay during the year because of the way you earn your income. Provisional tax helps you to spread the load and avoid a big end-of-year tax bill.

You must pay Provisional Tax if, at the end of the previous year, you were left with more than $2500 as tax payment. We call this amount your ‘Residual Income Tax’ (RIT), which is the amount of tax payable on your taxable income, less any PAYE deducted and any other tax credits to which you may be entitled (except Working for Families Tax Credits).

Residual Tax

Your RIT may exceed $2500 if you earn income without enough tax deducted to cover your income tax for the year. Examples are self-employed or rental income, scheduler payments or salaries and wages with a low PAYE rate, income from a partnership or look-through company, income from an estate or trust and overseas income.

In most cases, you pay Provisional Tax in three instalments during the year, based on what your estimate of your tax bill. When you file your income tax return and calculate your tax for the year, you deduct the Provisional Tax that you had paid earlier.

Any taxpayer who pays income tax may have to pay provisional tax. This includes individuals, companies and trusts.

An Example

Matt earns a salary and has Self-Employed Income.

Here is his 2014 Income Tax return: Salary $14,800 Plus Self-Employed Income (net profit) $ 47,600.

Taxable income: $62,400 Tax on taxable income $ 1,740; Less PAYE deducted from the salary (not including ACC Earners’ Levy) $1610 RIT $10,130

Matt’s 2014 RIT is more than $2500 and hence he must pay Provisional Tax for the 2015 tax year. When he files his 2015 return, he will deduct the Provisional Tax from his RIT, leaving a refund or End-of-Year Tax to pay.

The Concept

The date of payment of Provisional Tax instalments will depend on your balance date, namely the last day of your tax year.

The idea behind Provisional Tax is simple. You are trying to calculate an amount that will closely match the RIT that you expect for the following year. That way, when you complete your tax return and deduct your Provisional Tax, you should only have a small amount of End-of-Year Tax left to pay. You may even receive a refund.

Three Options

There are three ways to calculate Provisional Tax, namely, Standard Option, Estimation Option and Ratio Option

Since most people do not know how much tax they would be required to pay next year, calculating Provisional Tax usually involves good judgement. You must decide the most suitable Provisional Tax option.

If you do not make a choice, we will use the Standard Option. You can make your choice by filling in a box in your Income Tax return, sending us a secure email through myIR secure online services or by phone 0800-377774.

The Standard Option

The Standard Option assumes that your income will increase from year to year. Your Provisional Tax will equal your previous year’s RIT plus 5%. It is also the Fall-back option if you do not choose one.

When your provisional tax is due, you will pay three instalments on August 28, January 15 and May 7. But if you are registered for GST and you file six-monthly GST returns, you will only pay two instalments, on October 28 and May 7.

The standard option assumes that your income will increase from year to year.

An Example

Nicole earns scheduler payments that have tax deducted at a flat rate of 20%. Because 20% is less than her average tax rate, Nicole has End-of-Year Tax to pay. In May 2014, Nicole completes her 2014 Income Tax return. These are her Provisional Tax calculations:

Nicole will pay the first two instalments of her 2015 Provisional Tax at the same time as she is earning her 2015 income. She is distributing her tax burden and the final instalment is due after the end of her 2015 tax year.

Filing returns

When you use the Standard Option, your Provisional Tax is calculated from your previous year’s RIT. You must file your tax return on time, so that you will know your RIT before your instalments are due.

If you do not have an extension of time to file your return, you must file by July 7 every year. That gives you time to work out how much Provisional Tax you must pay and prepare for your first instalment on August 28.

If you file your returns late, you must still pay your Provisional Tax instalments on time. Complete your return so that you can work out how much you need to pay. Penalties and interest could be charged if you pay an instalment after the due date.

Extension of time

If you have an extension of time to file your tax return, you may have to pay an instalment of Provisional Tax before you know your RIT. If you are using a tax agent, they usually have an extension of time.

In this situation, you will calculate your Provisional Tax instalments using the RIT from two years ago, plus 10%. For more information, please visit our website.

Free Workshops

If you are in business, you may like to attend one of our free tax seminars or workshops held in various parts of the country. Please visit our website for details (www.ird.govt.nz).

Abdul Rafik is Inland Revenue’s Community Compliance Officer based in Auckland. He will answer your queries, which may be emailed to venkat@indiannewslink.co.nz