Provisional Tax 101

Imagine making loads of money during the year, but you never thought about keeping something aside for the tax man. Imagine the surprise you’d get at the end of the year when you get a huge bill from IRD.  

That’s why provisional tax was implemented. To avoid nasty surprises like that. 

Provisional tax is a ‘peace of mind’ tax. A ‘risk-reducing’ tax. 

Allow us to explain.

 

What Is Provisional Tax?

In simple terms, when you pay provisional tax, you are paying tax for the year you are currently in, even though you don’t know what your earnings will be yet. For instance, let’s say you estimated that your tax bill for 2021 will be $6,000. You will then pay three instalments of $2,000 each during the year. 

When you do your annual accounts at the end of the year, you’ll calculate tax on the actual profit. If you paid too little, you’ll have to make an additional payment, called terminal tax. If your actual profit is less than what you estimated, and you paid too much provisional tax, the IRD will refund the difference. 

Let’s say your tax bill for 2021 is $7,000 and you paid $6,000 in provisional tax throughout the year, you’d need to pay an additional $1,000. Similarly, if your final tax bill is only $5,000, and you paid $6,000 during the year, the IRD will refund $1,000 back to you.

Who Needs to Pay Provisional Tax?

You only need to pay provisional tax if your total tax bill (residual income tax) for the previous year was more than $5,000 (previously it was $2,500). You can still volunteer to pay provisional tax if your prior year’s tax was less than $5,000.

How Are Provisional Taxes Estimated? 

There are a few different options available to calculate provisional tax, but most businesses use the standard (safe harbour) option. 

On the standard option, the provisional tax payable is calculated as follows:

Residual income tax payable from prior year + 5% 

On this option, those with a balance date of 31 March will pay three instalments with the following deadlines: 

#1: 28 August

# 2: 15 January

#3: 7 May 

 

Payments May Overlap 

Something that often confuses our clients is that they’d need to make payments for both the current and the following year in the same year. For instance, your final bill for 2020 is due on 7 April 2021 (if you work through a tax agent like us). By this time, you would have already made two provisional payments towards the 2021 year. 

 

In Conclusion 

Provisional tax was put in place to help you avoid a huge tax bill at the end of the year. It’s designed to work similarly to Pay As You Earn (PAYE) that wage-earners pay on their monthly wages monthly. 

If you need any help or if you have more questions, get in touch with your account manager.

Tax Payments: Separating the Myths from the Facts

As with everything relating to COVID-19, there is a whole lot of information circulating about tax payments that sounds too good to be true. And some are.

We want to clear up a few of the common misinterpretations about the recent tax reliefs announced and make sure you understand which are actually available to you so that you don’t get into trouble with the IRD.

 

Myth #1: I Don’t Have to Pay Tax at the Moment

All core taxes are still payable as due and you still need to submit your returns on time. However, the IRD has indicated that they would be more lenient with late payments.

This doesn’t give you the green light to ignore taxes altogether. If you’re in a position to pay your taxes, you should do so. If you could have paid, and you didn’t, the IRD is not going to act favourably towards you.

If you are struggling to make any tax payments, there are some options available to you. Contact us so we can discuss those options and help you work out a payment plan that best suits your cash flow and keep you off the IRD’s black book.

 

Myth #2: The IRD Won’t Charge Any Interest or Penalties If I Don’t Pay

This is partially true. The IRD has relaxed the eligibility requirements for remitting interest and penalties, but these will still be imposed automatically by the IR system.

To have these reversed, you will need to apply for remission to the IRD as soon as practicable. You will also have to jump through all the standard hoops and provide them with financial information to show that your financial difficulties, and the reason you didn’t pay, were related to COVID-19. Financial information may include bank statements, management accounts, and cash flow forecasts, and we can help you to get these together.

Read more about the remission requirements here.

 

Myth #3: I Can Get the Tax Back That I Paid in the Prior Year

You may have heard that the IRD is allowing businesses to ‘carry back losses’, or in other words, that you can get a refund for tax you paid in the prior year if you’re making a loss in the current year.

It sounds great, but it’s only partially true. As always, the devil is in the details.

The first problem with this statement is that the IRD hasn’t issued any details on how they’ll apply this rule. They promised to give us more clarity on the 27th of April.

What we do know is that, in order to claim back taxes that were paid in the 2020 year, you’ll either have to wait until your 2021 annual accounts are completed, or you’d need to do some pretty accurate forecasting to estimate your losses for 2021. This is difficult in the best of times, but even more so now with all the uncertainty around the economy. It would take a pretty good crystal ball to forecast losses for the rest of the year. If you make a claim based on an estimate, you would have to prove your loss at the end of the year once your final accounts are completed.

If you made a loss in the 2020 year, claiming back taxes that were paid in the 2019 year would be a bit easier. If that’s you, please get in touch with us about getting your 2020 accounts completed earlier so you can take advantage of this relief sooner than later.

 

Final Provisional Tax Payment for 2020

The provisional tax due on 7 May is the final instalment for the year ended 31 March 2020. The shut down didn’t happen until the end of March so many of you had a good, or normal, year in 2020. The full impact of the lockdown won’t really hit us until the 2021 tax year.

If you have made normal profits for the year ended 31 March 2020, then remember that the tax thereon is still due.

So, the question of whether or not to pay your last provisional tax payment for 2020 comes down to…

  • your cash flow situation, or
  • whether you’re pretty certain that you’ll make a loss in the 2021 year.

In either case, please reach out to us to discuss your options.

 

You Can’t Get a Refund on Taxes You Didn’t Pay

Another question we sometimes get from clients is whether they can get a tax refund, even though they never paid any taxes. When messages about tax reliefs and refunds are all over the news, it’s easy to get swept up in the excitement and forget the simple principles of how the tax system works.

Remember, the IRD can’t refund something that you never paid.

 

Summary: Assessing Your Situation

As you can see, nothing is straight-forward and what applies to one business may not be relevant to another. Here’s a quick summary of the most important points to consider when deciding whether to pay your tax now or if you should apply for a tax refund due to future losses: 

  • If you’re in a sound cash flow position and it looks promising that you’ll make a profit in the 2020 and 2021 years, pay your taxes.
  • If cash flow is tight, come talk to us about your options. We can introduce you to working through Tax Traders, a tax financing company, which gives you cheaper and more flexible payment options. Alternatively, we can help you to arrange a repayment agreement with the IRD.
  • If you made a loss in the 2020 year, but in prior years you made a profit, you can apply to the IRD to carry back your losses. Ask us to help you complete your annual accounts earlier.
  • If you expect to make a loss in the 2021 year, and you want to request that the loss is carried back to prior years, you’ll need an accurate cash flow forecast. Get in touch if you want us to help you to create a realistic forecast — we can’t see into the future, but we’re as near as you could get to a crystal ball.

 

The tax rules and interpretations are constantly changing. We’ll keep you informed of these changes via our newsletter.