Provisional Tax Made Simple

Most of you will have heard recent releases from IRD relating to their New Provisional Tax option for Small Businesses called AIM (Accounting Income Method).

They’re saying: “Once you’ve opted in to AIM you’ll only pay provisional tax when your business makes a profit. This will help you to avoid cash flow problems. As long as you make your payments in full and on time, there is no exposure to use-of-money interest. If your business makes a loss you can get your refund straightaway rather than waiting until the end of the year.”

This sounds great, and if the stars align it would be very useful.  But we all know the stars don’t always align and we believe this doesn’t work for everyone.

To see if this method will work for you – read on.

 

To be eligible to use this method you must meet the following criteria:

  • have annual gross income of under $5 million
  • use an AIM-capable software system (currently just Xero and certain online versions of Reckon and MYOB)
  • not be a Trust or a Partnership – i.e. you must be a sole trader or a company
  • not have any FIF investments

 

If you are eligible and opt to use this method, you need to “elect in” using your accounting software at the beginning of the financial year. For most of you that will be 1 April.

Then, and here’s the catch –  there is a bit of extra work required each GST period.

IRD have provided a list of up to 10 determinations that need to be considered (and adjusted for) each GST period, you will need to consider which ones you will need to make. For all the options below, where there are choices available, whichever treatment you use in the first period will need to be applied consistently for the whole year. Not all will be relevant to everyone so would need to be looked at on a case by case basis.

The options include:

 

  • Accounts Payable and Accounts Receivable

Monthly accounts prepared through software packages could be prepared on a cash basis (i.e. not recognising accounts payable or accounts receivable) or on a full accruals basis where accounts payable and accounts receivable are recognised and accounted for.

If a business accounting system ignores accounts payable and receivable and (if the business is registered for GST) it is registered on a payments basis, then the accounting profits prepared on this basis are acceptable to determine the profit for the tax payments applying the AIM provisional tax method.

So, if you use debtors or creditors in your accounting software, you will need to ensure they are all accrued correctly to be included in calculation. If you don’t record them in your software, you will either need to enter them manually or opt to record on a cash basis. If you opt for calculation on a cash basis, then there is likely to be a tax adjustment needed at end of the period (extra tax to pay).

 

  • Shareholder salaries where no PAYE is deducted

In many companies, all- or a significant portion of- the annual taxable profit is paid to its shareholder employees as wages outside the PAYE rules. In this case, those shareholders and the company are likely to all be subject to provisional tax.

The AIM rules provide some relatively complex rules for this. In working out the tax payable by the company, a deduction is allowed for the lesser of:

  • a provision for shareholder salaries
  • the income of the shareholder employee based on the tax paid by the company on behalf of the shareholder employee.

In our experience, most companies that pay shareholder salaries do not make any provision for salaries payable to shareholder employees until the end of the year accounts are prepared and the final profits are known.  This means there is no deduction to the company in determining its AIM provisional tax payments during the year.  All tax on profits will therefore be paid at 28% by the company.  That is, the combined profit of the company and shareholder salaries has provisional tax paid at 28% without the benefit of the lower income tax rates applying to shareholder salaries below $48,000, or taking into account that a shareholder may pay tax at 33% on income earned over $70,000.

Whether this is overpaying tax or underpaying tax will be dependent on the overall taxable profits.

Where a company pays provisional tax on all the profits (excluding any deduction for shareholder employee salaries) at 28%, at the end of the year, the company can transfer the excess tax payments to the shareholders to satisfy the shareholder employees’ provisional tax obligations.  While the AIM provisional tax payments will occur across the year, the transfer to the shareholder employees will be deemed to occur equally at the provisional tax payment dates.  If this is not sufficient to satisfy the shareholder employees final liability, they will either have had to pay provisional tax or buy provisional tax through a tax pool to satisfy any shortfall (and therefore any exposure to penalties and interest).

Basically, it is likely that if you use this method and pay shareholder salaries, it is likely that you will also need to accrue shareholder salaries regularly in your accounts and pay provisional tax for the shareholders based on that.

 

  • Tax losses and offsets

If you have any losses to offset they won’t be brought into AIM calculation and losses will only be recorded from filed tax returns, so you will generally be better off sticking to existing standard uplift method.

 

  • Private Expenditure

To use AIM for provisional tax, any expenditure that has a private portion element (other than entertainment expenditure) must be adjusted for each AIM instalment period. This relates to vehicle expenses and home office costs etc. If you currently leave this adjustment to us to undertake when preparing the annual tax return, then this practice is not acceptable and probably AIM should not be applied.

 

  • Trading Stock

If you have a perpetual stock system, stock will need to be recorded each period. Otherwise you will need to decide whether you make an adjustment each period or use the opening stock value figure throughout the year and then adjust at year end. This may have a significant effect on the provisional tax payments you make, so we would recommend discussing this with us.

 

  • Depreciation

Again, this allows you to make a choice whether to adjust each period or leave until year end. If you decided not to depreciate each period, the deduction will not be recorded in your provisional tax calculations. If you do depreciate, you will need to run an up to date depreciation schedule, update and calculate losses/gains on disposal each period.

 

As mentioned earlier, if your circumstances fit and you already meet most of the requirements (and you are happy to make smaller, more frequent provisional tax payments) this can be a very useful method to take some of the pain out of calculating/paying provisional tax.

 

Some of the above has been paraphrased from an article prepared by Tax Traders.

If you would like to know more about this or other tax options see the full article here and IRD’s determinations here or come along to the seminar we are holding on 20 February (register here).

 

If you have any queries give Clayton a call.

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