Paying provisional tax interest is widely disliked. The Christmas-New Year period is a good time to take stock of how you have been trading throughout the year for tax purposes. By the time you are popping the corks on New Year’s Eve, nine months of the financial year will have passed. That as good a time as any to check to see if you’ll need to ‘top-up’ your provisional tax payments for the current financial year.
You may find that you have been enjoying a particularly strong year in terms of income. If this is the case, you may find that your actual tax liability may exceed the provisional payments you have made. This may give rise to an interest bill from the IRD if the provisional tax you have paid is less than your residual income tax. Conversely, if the amount of provisional tax you have paid exceeds the residual income tax, the IRD will pay you interest. Needless to say, the interest rates applied in either instance are very different.
Most businesses and self employed people have to pay provisional tax. If you have residual income tax (RIT) of more than $2,500, you must pay provisional tax for the following year.
The default system for the IRD is called the Standard Option. It’s a very simple formula. They take your RIT from the previous year, add a 5% uplift, and ask you to pay a third of that figure over three separate installments in August, January and May.
To work out what your residual income tax will be:
- Add up all your estimated income for the year. If you do this in January, you’ll need to forecast the last three months of trading for that financial year.
- Work out the tax on the total.
- Subtract any tax credits (such as PAYE or RWT)
If you would like us to do this for you, please get in touch.
You can estimate your provisional tax as many times as you like up until the last installment in May. The only rule is that your estimate must be fair and reasonable.
If your provisional tax is inadequate, you can make voluntary repayments of income tax at any time up to the final installment.
Alternatively, you can use tax pooling to minimise interest. You can read more about that in a separate blog post here.