Provisional Tax changes
The government has signalled some significant changes to Provisional Tax from 2017.
Specific details are still being worked through and nothing has been finalised but we are able to highlight some of the key recommendations:
- The threshold for Use of Money Interest would increase from $50,000 to $60,000
- Use of Money Interest would be removed entirely from the first two provisional tax payments (typically August and January) so long as payments are made on time using the standard option
- Introducing a new method of provisional tax payment to be called the Accounting Income Method (AIM) from 1 April, 2018
- Allow a company to pay tax for shareholder-employees to reduce the impact of provisional tax on the shareholders
- Allow contractors to determine their own level of withholding tax (rather than the default amount) to reduce the impact of provisional tax
The Current Situation
There are two common ways to calculate provisional tax.
For most businesses and self-employed people, the standard (or ‘uplift’) option applies. This means that your provisional tax payments are based on 105% of last year’s residual income tax.
Some businesses elect to estimate their provisional tax. This is quite common if the business has encountered tough trading conditions and the directors forecast lower earnings and therefore profit for the year ahead. Interestingly, of 300,000 provisional taxpayers, nearly three-quarters are individuals and yet three-quarters of provisional tax collected is from companies.
The third method, the GST ratio method, is less common. It bases your provisional tax payments on a percentage of your GST taxable supplies
Use of Money Interest
Use of Money interest (UoMI) is a punitive regime to encourage taxpayers to pay provisional tax accurately and on time. However, many businesses and individuals do not have the use of a crystal ball. Directors and individuals often cannot know with any certainty how much tax will be payable until the financial year is almost over. Income is very seldom evenly spread throughout the year. This means that taxpayers and accountants spend a lot of time estimating what their profit will be for the year to see if they have paid enough provisional tax. It goes without saying that this is highly unproductive. If too little provisional tax has been paid, UoMI is currently applied from the very first provisional tax date in August. Tax pooling and tax finance can be used to reduce the interest and eliminate penalties.
The Key Proposals in more detail
Smaller individual taxpayers were previously excluded from the provisional tax regime through the safe harbour rule. If you have less than $50,000 in residual income tax to pay, UoMI does not apply. It is proposed that the threshold be increased to $60,000 and entities other than individuals will be able to use it. This means that smaller companies will now be excluded from the UoMI regime. A number of other criteria will apply.
For those that have residual income tax over $60,000, the UoMI regime would be removed for the first two provisional tax payments. This will be much fairer particularly for businesses that have fluctuating revenue.
A brand new method for calculating provisional tax will also be introduced called the Accounting Income Method (AIM). This will be available to all taxpayers turning over $5,000,000 or less. AIM payments will only be offered to taxpayers using using suitable accounting software. Payments will be made at the same time as GST – either monthly, two-monthly or six-monthly. The accounting software will need to be able to calculate adjustments for non-GST items such as wages and salaries, interest and depreciation. Calculations would exclude payments to shareholder-employees. Unfortunately tax pooling would not be available when using this method so calculations will need to be precise.
AIM will suit taxpayers whose income doesn’t fluctuate significantly, who are consistently profitable in every month of the year (rather than record losses in certain months) or who have a larger part of the income concentrated in the second half of the financial year.
You can see a typically effervescent video on the topic by Rod Drury, MD of Xero, by clicking on the link here.
IRD are seeking feedback on the proposals with a deadline for submissions of 30 May, 2016. Submissions can be made on the Making Tax Simpler website here.
We’ll post an update once the initial legislation is drafted. In the meantime it’s business as usual and there are no changes for anyone yet. The final changes will take effect from 1 April, 2017. If you want more information, don’t hesitate to contact us.