What is Provisional Tax?
Provisional tax is a concept that can initially be confusing for many business owners and taxpayers. The fundamental question arises: Why pay tax in parts instead of one large payment at the end of the year?
At it's simplest level, provisional tax is a prepayment of your terminal tax during the year (ie your final tax due at the end of the year). This helps to mitigate a large tax bill during the year (and obviously means IRD gets their money sooner).
The common misconception is with provisional tax that you're paying tax in advance of earning the profit (ie the 28 Aug 2023 provisional tax payment is for tax due for the year end 31 March 2024). On the face of it yes, but the financial year runs from 1 Apr 2023 to 31 Mar 2024 so by the time the 28th of August payment rolls around you would have already earned profit for 4 months from 1 April to 31 July so this payment will in theory represent 1/3 of your tax due.
With that said without provisional tax, you could potentially keep that tax money amount for a whole 12 months.
Who is a Provisional Taxpayer?
If your Residual Income Tax (RIT) (which is total income x the tax rate less tax credits) exceeds $5,000 annually, you become a provisional taxpayer.
This usually arises due to
Business income
Contractors without withholding tax.
Rental property income
Crypto income gains
How is Provisional Tax Calculated?
If your Residual Income Tax for the year ended 31 Mar 2023 was $6,500, IRD will apply the standard uplift of 5% to this so your provisional tax obligation will be $6,825 ($6,500 x 1.05) for the year ended 31 March 2024.
For most taxpayers your provisional tax payments will be as below
28 August 2023 - $2,275
15 January 2024 - $2,275
7 May 2024 - $2,275
If you are registered for GST on a 6 monthly basis your payments will be as below
P1 - 28 October 2023 - $3,412.50
P2 - 7 May 2024 - $3,412.50
Fluctuations in Income:
Obviously it is rare that your growth will be exactly 5% each year (could be higher, could be lower)
Earning More: If your actual Residual Income Tax is more than a 5% growth on last year, it will mean, even after making the three provisional tax payments, there will still be a balance of tax due so you will have a 2023 terminal tax payment due 7 Apr 2024
Earning Less: If your actual Residual Income Tax is less than a 5% growth on last year, you will either have a refund for your 2023 terminal tax, or you may not have to make some or any of the provisional tax payments during the year.
The First Year Business Trap:
For a business that commenced on 1st April 2022, the first tax return wouldn't be due until 31 March 2023, and the first tax payments won't be until the below
2023 terminal tax - 7 April 2024
2024 provisional tax - 7 May 2024 (assuming the return was filed after 15 Jan 2024)
What this means is that you have essentially not paid tax for two consecutive years and then have two full years of tax due in two months.
Without planning and preparing for this the often forgotten tax bill can sink small businesses.
In conclusion, understanding provisional tax and its implications is crucial for every business owner. It not only helps in better financial planning but also avoids potential pitfalls that could challenge a business's survival.
What is Provisional Tax?
Provisional tax is a concept that can initially be confusing for many business owners and taxpayers. The fundamental question arises: Why pay tax in parts instead of one large payment at the end of the year?
At it's simplest level, provisional tax is a prepayment of your terminal tax during the year (ie your final tax due at the end of the year). This helps to mitigate a large tax bill during the year (and obviously means IRD gets their money sooner).
The common misconception is with provisional tax that you're paying tax in advance of earning the profit (ie the 28 Aug 2023 provisional tax payment is for tax due for the year end 31 March 2024). On the face of it yes, but the financial year runs from 1 Apr 2023 to 31 Mar 2024 so by the time the 28th of August payment rolls around you would have already earned profit for 4 months from 1 April to 31 July so this payment will in theory represent 1/3 of your tax due.
With that said without provisional tax, you could potentially keep that tax money amount for a whole 12 months.
Who is a Provisional Taxpayer?
If your Residual Income Tax (RIT) (which is total income x the tax rate less tax credits) exceeds $5,000 annually, you become a provisional taxpayer.
This usually arises due to
Business income
Contractors without withholding tax.
Rental property income
Crypto income gains
How is Provisional Tax Calculated?
If your Residual Income Tax for the year ended 31 Mar 2023 was $6,500, IRD will apply the standard uplift of 5% to this so your provisional tax obligation will be $6,825 ($6,500 x 1.05) for the year ended 31 March 2024.
For most taxpayers your provisional tax payments will be as below
28 August 2023 - $2,275
15 January 2024 - $2,275
7 May 2024 - $2,275
If you are registered for GST on a 6 monthly basis your payments will be as below
P1 - 28 October 2023 - $3,412.50
P2 - 7 May 2024 - $3,412.50
Fluctuations in Income:
Obviously it is rare that your growth will be exactly 5% each year (could be higher, could be lower)
Earning More: If your actual Residual Income Tax is more than a 5% growth on last year, it will mean, even after making the three provisional tax payments, there will still be a balance of tax due so you will have a 2023 terminal tax payment due 7 Apr 2024
Earning Less: If your actual Residual Income Tax is less than a 5% growth on last year, you will either have a refund for your 2023 terminal tax, or you may not have to make some or any of the provisional tax payments during the year.
The First Year Business Trap:
For a business that commenced on 1st April 2022, the first tax return wouldn't be due until 31 March 2023, and the first tax payments won't be until the below
2023 terminal tax - 7 April 2024
2024 provisional tax - 7 May 2024 (assuming the return was filed after 15 Jan 2024)
What this means is that you have essentially not paid tax for two consecutive years and then have two full years of tax due in two months.
Without planning and preparing for this the often forgotten tax bill can sink small businesses.
In conclusion, understanding provisional tax and its implications is crucial for every business owner. It not only helps in better financial planning but also avoids potential pitfalls that could challenge a business's survival.
What is Provisional Tax?
Provisional tax is a concept that can initially be confusing for many business owners and taxpayers. The fundamental question arises: Why pay tax in parts instead of one large payment at the end of the year?
At it's simplest level, provisional tax is a prepayment of your terminal tax during the year (ie your final tax due at the end of the year). This helps to mitigate a large tax bill during the year (and obviously means IRD gets their money sooner).
The common misconception is with provisional tax that you're paying tax in advance of earning the profit (ie the 28 Aug 2023 provisional tax payment is for tax due for the year end 31 March 2024). On the face of it yes, but the financial year runs from 1 Apr 2023 to 31 Mar 2024 so by the time the 28th of August payment rolls around you would have already earned profit for 4 months from 1 April to 31 July so this payment will in theory represent 1/3 of your tax due.
With that said without provisional tax, you could potentially keep that tax money amount for a whole 12 months.
Who is a Provisional Taxpayer?
If your Residual Income Tax (RIT) (which is total income x the tax rate less tax credits) exceeds $5,000 annually, you become a provisional taxpayer.
This usually arises due to
Business income
Contractors without withholding tax.
Rental property income
Crypto income gains
How is Provisional Tax Calculated?
If your Residual Income Tax for the year ended 31 Mar 2023 was $6,500, IRD will apply the standard uplift of 5% to this so your provisional tax obligation will be $6,825 ($6,500 x 1.05) for the year ended 31 March 2024.
For most taxpayers your provisional tax payments will be as below
28 August 2023 - $2,275
15 January 2024 - $2,275
7 May 2024 - $2,275
If you are registered for GST on a 6 monthly basis your payments will be as below
P1 - 28 October 2023 - $3,412.50
P2 - 7 May 2024 - $3,412.50
Fluctuations in Income:
Obviously it is rare that your growth will be exactly 5% each year (could be higher, could be lower)
Earning More: If your actual Residual Income Tax is more than a 5% growth on last year, it will mean, even after making the three provisional tax payments, there will still be a balance of tax due so you will have a 2023 terminal tax payment due 7 Apr 2024
Earning Less: If your actual Residual Income Tax is less than a 5% growth on last year, you will either have a refund for your 2023 terminal tax, or you may not have to make some or any of the provisional tax payments during the year.
The First Year Business Trap:
For a business that commenced on 1st April 2022, the first tax return wouldn't be due until 31 March 2023, and the first tax payments won't be until the below
2023 terminal tax - 7 April 2024
2024 provisional tax - 7 May 2024 (assuming the return was filed after 15 Jan 2024)
What this means is that you have essentially not paid tax for two consecutive years and then have two full years of tax due in two months.
Without planning and preparing for this the often forgotten tax bill can sink small businesses.
In conclusion, understanding provisional tax and its implications is crucial for every business owner. It not only helps in better financial planning but also avoids potential pitfalls that could challenge a business's survival.
