In New Zealand the provisional tax regime is designed to help taxpayers manage their income tax obligations, by requiring certain taxpayers to pay tax in instalments throughout the year, instead of one large lump sum at the end of the year. This regime applies to taxpayers who have residual income tax (RIT) of greater than $5,000 in a tax year – RIT is the amount of income tax payable by a taxpayer after deducting tax credits (e.g. RWT, PAYE).
A provisional taxpayer has four different options available when determining the amount to pay at each instalment:
- Standard uplift – based on the previous year’s RIT + 5%. Where the prior year tax return has not been filed, the payment will be based on RIT from two years ago + 10%.
- Estimation – this option allows you to estimate what tax you think you should pay. This is often used where income is expected to be less than the prior year.
- Ratio – payments are calculated as a percentage of GST taxable supplies.
- AIM (Accounting Income Method) – payments are calculated through accounting software, which allows smaller amounts to be paid more frequently.
Where a taxpayer fails to meet their provisional tax obligations, they will be subject to interest and penalties on any underpaid tax. The current interest rate applying from 17 January 2023 is 9.21% on underpaid tax.
The provisional tax regime has been subject to several concessional changes over the past 10 years, for example:
- As a result of COVID-19, the RIT threshold increased from $2,500 to $5,000, thereby reducing the number of taxpayers subject to the provisional tax regime.
- Where a taxpayer’s RIT is less than $60,000, and the amount of provisional tax paid during the year using the standard uplift method results in a shortfall, they will be not be charged interest or penalties provided the shortfall is paid by terminal tax date.
Where a taxpayer’s RIT is $60,000 or more, and they have paid provisional tax using the standard uplift method, they will only be charged interest from the final provisional tax instalment date. Historically interest and penalties could apply from each instalment date, even if a taxpayer had used the standard uplift method.
One other option that should not be overlooked is to use a tax pooling intermediary to manage provisional tax obligations. Tax pooling is a mechanism by which tax credits effective at a historic date can be purchased from another taxpayer at an interest rate that is less than what Inland Revenue charge.
Between the above concessionary changes enacted over recent years and the option of using tax pooling, the days of incurring large interest and penalty charges with Inland Revenue are in the past.