You filed your IR4 Company Tax Return but now comes the point where your Provisional Tax is due and you're not sure if you chose the right amount, the right method or how it all works.
Here are a few guidelines for business owners:
Instead of trying to work out how much tax you need to pay over the course of a year and getting it wildly incorrect or overestimating and holding onto funds that can be better utilised back in the business, Provisional Tax is paid in instalments throughout the year and is paid on income higher than $2,500 in the previous tax year.
After you file your IR4 Tax Return (hopefully correctly), you'll receive a letter confirming receipt of your return and also a notice advising you how much Provisional Tax is due (or to be refunded) and when. Typically, if you have a March balance date like most companies, your first instalment is due in August but the IRD have a handy Calendar Reminder to enable you to check if you're unsure: Inland Revenue’s calendar reminder
When you filled out your Tax Return (IR4), you would have had the choice of calculation methods based on your expected profit for the year:
- Estimation (the most popular choice for new businesses) is based on your estimated Residual Income Tax (RIT) for the year. This method is great for new business owners who can't predict how their business will perform in the first (and most volatile) year of business.
If you choose Estimation and estimate incorrectly, you are able to rectify it by making voluntary payments throughout the year - this is great if your business picks up much faster than you expected and your income is higher than your initial estimation.
It's important to be realistic though because if your estimation is wildly below what your actual income is, even if you make voluntary payments, there will be penalties.
- Standard is based on your previous year’s RIT plus a buffer of 5% as expected growth. This is great for established businesses who have a grasp of how their business performs and of any financial fluctuations.
- Ratio is based on your GST taxable supplies. This option is great for businesses who can easily calculate their Cost of Goods Sold (COGS).
If you don't choose a method, you'll automatically be charged as 'Standard' which may seem like the easy way but there are exceptions which can be of great benefit to a new business.
While your first year in business isn't tax-free, you won't need to pay if your previous year's RIT is below $2,500. Similarly, if your expenses far outweigh your income when your first return is due, you likely won't need to pay any tax. However, if your RIT is over the $2,500 threshold at the end of the financial year, you may have to pay provisional tax for your second year on top of the tax due from your first year so you should plan and budget for a payment throughout the year.
While this isn't a comprehensive 'how-to' on Provisional Tax, we hope we've shed a little light on it in a simple easy-to-understand manner. The IRD have a created a really helpful complete guide to Provisional Tax for the non-financial business owner which is a godsend when you're just starting out and have no idea what it all means.