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Provisional tax

In the following scenarios we compare the accounting income method (AIM) to the standard, ratio, and estimation provisional tax options. These scenarios look at types of businesses that could most benefit from AIM because they are:

  • new or growing
  • earning irregular or seasonal income
  • unable to accurately forecast their income.

Scenario

Lydia is an avocado farmer and earns her profit between September and April.

How Lydia pays provisional tax

Lydia uses the standard option to work out her provisional tax because her profits usually increase year to year.

Based on last year’s end-of-year tax assessment, she needs to pay $120,000 for her provisional tax this year. She makes a $40,000 payment in August, January and May. The August payment is difficult for Lydia because she makes most of her money between September and April.

How Lydia's year shapes up using the standard option

April to May the following year timeline of provisional tax payments. Previous years' provisional tax due to May. 3 payments of $40,000 for current years' provisional tax due in August, January and May.

How Lydia could benefit from AIM

Lydia would pay her provisional tax based on the money she made throughout the year. Lydia’s software would calculate smaller, more frequent payments. These would align with her cash flow when she submits her monthly statement of activity. Since her income fluctuates, she could request a refund for overpaid tax in the current year instead of waiting until year end. AIM is the only provisional tax option that allows this.

How Lydia's year shapes up using AIM

April to March timeline of Lydia’s year using AIM. Lydia gets the following refunds for the months without any profit, 2,100 in May, and 12,200 in August. Lydia pays the following provisional tax amounts for months she makes a profit, 35,000 in April, 14,900 in September, 11,000 in October, 20,400 in November, 19,800 in December, 14,400 in January, 4,500 in February, and 14,300 in March. In June and July there was no refund or payment.

Conclusion

Lydia finds it easier to manage her provisional tax payments using AIM and now has more time for maintaining her avocado farm during the busy season.

Scenario

John is a commercial fisher and owns his own boat. He can claim his boat as a depreciable asset, which will reduce his income tax.

How John pays provisional tax

John uses the ratio option to work out his provisional tax because his income fluctuates.

John's provisional tax lines up with his two-monthly GST returns. He pays 6 provisional tax payments during the year, based on his GST taxable supplies, totalling $59,800. He includes his depreciation expense in his end-of-year tax return which results in an assessment of $47,800. As it turns out, he gets a refund of $12,000 for overpaid tax.

How John's year shapes up using the ratio option

April to March timeline of provisional tax when using the ratio method. 6 different provisional tax payments were made during the year as they are based on business turnover. 15,000 paid in May, 18,000 paid in July, 1,500 paid in September, 24,000 paid in November, 500 paid in January, and 800 paid in March. In March an end-of-year tax refund of 12,000 was issued.

How John could benefit from AIM

Instead of waiting until year end, John would include his boat's depreciation expense when submitting his statement of activity every 2 months. He would end up paying less money when he made a profit and get money back on months he did not.

How John's year shapes up using AIM

April to March timeline of John’s year using AIM. John gets the following refunds for the months without any profit, 500 in September, 1,500 in January, and 1,200 in March. John pays the following provisional tax amounts for months he makes a profit, 13,000 in May, 16,000 in July, and 22,000 in November.

Conclusion

John does not need to wait to receive his refund, making his cash flow easier to manage. When he files his end-of-year tax return there is no refund or further tax to pay because he already accounted for his income and expenses using AIM.

Scenario

Hemi and Aroha run a small film production company and their income changes a lot based on contracts they win for jobs.

How Hemi and Aroha pay provisional tax

Hemi and Aroha are unsure how much they'll make each year, so they use the estimation option. They estimate that they'll owe $30,000, and make their first $10,000 payment in August.

Over Christmas they win a new film contract. Hemi contacts IRD in January to increase their estimate to $60,000 based on the extra income. They make their next 2 payments of $25,000 in January and May based on the new estimation.

When they file their end-of-year tax return, they get a $57,000 tax assessment. Since they made their payments on time, they do not receive any penalties. But, interest is calculated on the difference between $19,000 (one third of the assessment) and the tax paid on each date.

How Hemi and Aroha's year shapes up using the estimation option

April to May the following year timeline of provisional tax estimates and payments using the estimation option. Provisional tax estimate of 30 thousand made in April for the tax year. This was re-estimated to 60 thousand in January. The end-of-year tax assessment is 57 thousand. A provisional tax payment of 10 thousand was made in August based on the original estimate, then 2 payments of 25 thousand made in January and May based on the re-estimated figure.

How Hemi and Aroha could benefit from AIM

Hemi and Aroha would send us a statement of activity every month when they file their GST. They would only need to make provisional tax payments in June, December and January, when they made their profit. Their software would work out that nothing was due to be paid on the months that they did not earn an income.

How Hemi and Aroha's year shapes up using AIM

April to March timeline of Hemi and Aroha’s year using AIM. Hemi and Aroha file a Statement of activity every month. They only made a profit in 3 months of the year so most of their statements are nil. The provisional tax payments they paid were 8,500 for June, 15,000 for December, and 33,500 for January when they made profits.

Conclusion

Hemi and Aroha will not need to re-estimate their provisional tax if they earn more income. Also, they will not be charged interest due to underestimations if they pay what their software tells them to, in full and on time. They're less stressed and have more time to focus on growing their business.

Last updated: 28 Apr 2021
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