Understanding Provisional Tax
Provisional Tax is Income Tax you pay during the year, helping you “spread your tax load” and avoid a big end-of-year tax bill - it is not a separate tax. You pay Income Tax in instalments during the year, based on the profit you expect to earn for the whole year. The amount of provisional tax you pay is then deducted from your tax bill (Residual Income Tax) at the end of the year.
If your Residual Income Tax (RIT) is $2,500 or more you will have to pay Provisional Tax for the following year. RIT is the amount of tax to pay on your taxable income, less any PAYE deducted and any other tax credits. Residual income tax is clearly labelled in your tax return.
There are two common options for working out your provisional tax: Standard and Estimation.
The IRD automatically charges provisional tax using the Standard Option unless you choose the Estimation Option. Under this option:
- Your provisional tax payable amount equals your previous year's RIT plus 5%. This is also called ‘Standard Uplift’.
- You will have to pay three installments on 28 August, 15 January and 7 May. But if you are registered for GST and you file six-monthly GST returns, you will only pay two installments, on 28 October and 7 May.
- Change in the tax rates may have an effect on the calculation of your Provisional Tax.
- If your RIT is $50,000 or more, in most cases the estimate method is the best to use. The IRD charges interest if your RIT is over $50,000 and insufficient provisional tax is paid.
- Interest is payable on Company and Trusts if insufficient provisional tax is paid.
The other way to work out your provisional tax is to estimate what your residual income tax will be. When working out the tax, keep the following points in mind.
- To get the right tax amount you need to:
- add up all your estimated income
- work out the tax on the total
- then subtract any PAYE and other tax credits
- As with the standard option, you will have to pay three installments on 28 August, 15 January and 7 May. But if you are registered for GST and you file six-monthly GST returns, again, you will only pay two installments, on 28 October and 7 May.
- Using the estimation option, if your estimated residual income tax is lower than your actual residual income tax for that year, you may be liable for interest on the underpaid amount.
- You can estimate your provisional tax as many times as necessary up until your last installment date. Each estimate must be fair and reasonable.
If you overpay your Provisional Tax for any reason, this will be refunded to you once your tax return is assessed by Inland Revenue.