The government’s issues paper, which is open for submissions until 30th May 2016, outlines 16 proposed measures on a number of areas including Provisional Tax. Here UHY Haines Norton’s Jim Martin takes a closer look at the Provisional Tax proposals and their implications for business owners.
Provisional Tax is the payment of Income Tax on account during a year towards the business’ overall tax liability. Provisional Tax applies where income does not have any tax deducted at source, e.g. Business Profits or where insufficient RWT on Interest has been deducted. This results in catch-up tax becoming due. Residual Income Tax (RIT) is designed to minimise this catch-up tax, otherwise IRD would charge Use of Money Interest (UOMI).
Provisional Tax makes up nearly a quarter of government tax collected and is collected over three instalments during the year.
Proposed Changes to Provisional Tax
- Use of Money Interest (UOMI) charged by IRD on short paid tax will not apply until RIT is $60,000 or more (the current threshold is $50,000). It is also proposed to extend this concession to non-individuals like Companies and Trusts. Effective from 1 April 2017 if passed.
- Remove UOMI on the first and second Provisional Tax instalments, where the Taxpayer uses the Standard Uplift Method for calculating their Provisional Tax, i.e. last year’s RIT plus 5%. Exemption from UOMI will be dependent upon the Taxpayer making the Provisional Tax payments by their due date. Effective from 1 April 2017 if passed.
- Introduction of another method for calculating Provisional Tax: the Accounting Income Method (AIM) for Small- and Medium- Sized Enterprises (SMEs), where the SME’s annual turnover is $5.0m or less. No UOMI will be charged where Provisional Tax is paid based on the figures calculated by the relevant software. AIM may not suit businesses that:
a) Do not have robust accounting systems
b) Have seasonal income concentrated in the beginning of the year
c) Have large amounts of overseas income resulting in large year-end adjustments
d) Have complex tax adjustments that require year-end calculations
Effective from 1 April 2018 if passed.
- Allow closely held companies (companies controlled by 5 or fewer shareholders) to pay Provisional Tax on behalf of their shareholder-employees, i.e. where those shareholder-employees are paid or credited a non-PAYE salary from the company. This would enable some shareholders to be removed from the Provisional Tax rules. Effective from 1 April 2018 if passed.
Implications for Business Owners
All of these Provisional Tax proposals are taxpayer friendly and we will welcome their implementation once passed.
The AIM option for calculating Provisional Tax is intended to work with cloud-based software, which is expected to become more integrated with IRD systems. The plan is that SMEs will use their accounting software in conjunction with their professional advisers (their Accountant) to track and review their performance during the year and thereby have improved information to both run their business and to calculate Provisional Tax on an actual results basis.
The Provisional Tax payments would also be aligned with GST payment dates so that tax is paid as it is earned.
An end of year tax return will still need to be filed, but it is expected that no significant adjustments should be required. Under the AIM option, IRD will expect taxpayers to exercise reasonable care when calculating their Provisional Tax. IRD have stated that UOMI and Shortfall Penalties of 20% on the tax shortfall could be charged where taxpayers have not exercised reasonable care when calculating the payment due. This highlights the need for the involvement of an accountant around each tax payment date to ensure that the in-house accounts are properly prepared and the resultant Provisional Tax instalments are correctly calculated. Any over payment of Provisional Tax under AIM can be transferred to shareholder-employees to cover their tax obligations.