Provisional tax is not a separate tax but a way of paying your income tax as the income is received through the year. You pay instalments of income tax during the year, based on what you expect your tax bill to be. The amount of provisional tax you pay is then deducted from your tax bill at the end of the year.
If you’re residual income tax (RIT) is $5,000 or more, you will have to pay provisional tax for the following year. Residual income tax is basically the tax to pay after subtracting any rebates you are eligible for and any tax credits (excluding provisional tax). Residual income tax is clearly labelled in the tax calculation in your tax return.
There are four options for working out your provisional tax: standard, estimation, accounting income method and ratio option.
The IRD automatically charges provisional tax using the standard option unless you choose the estimation option. With the Standard option provisional tax payable is your previous year’s residual income tax (RIT) plus 5%.
If you use this standard option, you’ll pay 3 equal instalments during the year. If you are registered for GST and file 6 monthly returns, you’ll only pay 2 instalments.
The estimation option helps to avoid overpaying or underpaying your provisional tax.
With the estimation option you estimate what your residual income tax will be. When working out the tax, keep the following points in mind.
– to get the right tax rate
– add up all your estimated income
– work out the tax on the total
– then subtract any tax credits (like PAYE)
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 instalment date. Each estimate must be fair and reasonable.
This method is available to individuals and companies with a yearly turnover under $5 million. You’ll only pay provisional tax when your business makes a profit. If you make your payments in full and on time, IRD will not charge use of money interest.
The ratio option lets you match your provisional tax payments with your cashflow. It also bases your provisional tax payments on a percentage of your GST-taxable supplies. This option is useful if your income varies or you have seasonal income
In some circumstances you may be charged interest if the provisional tax you paid is less than your residual income tax. If the provisional tax you pay is more than your residual income tax, the IRD may pay you interest on the difference.