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Provisional tax
Tāke tārewa

Calculating provisional tax

Find out about the different options for working out provisional tax and choose the best option for you.

Options for working out provisional tax

Working out provisional tax using the standard, estimation or ratio options involves some judgement. You're trying to work out an amount that will closely match the residual income tax (RIT) you expect for the following year. That way, when you complete your income tax return and deduct your provisional tax, you should only have a small amount of end-of-year tax left to pay. You may even receive a refund.

If you're using the accounting income method (AIM), your accounting software will work out your payments for you. Payments are worked out based on the profit your business has made in that payment period.

What residual income tax (RIT) is

Residual income tax (RIT) is the amount of income tax you pay for the year, less any PAYE and other tax credits you may be entitled to, except for Working for Families Tax Credits.

There are four ways to work out provisional tax. You'll need to choose the best option for you:

  1. Standard option
  2. Accounting income method (AIM)
  3. Estimation option
  4. Ratio option (for GST registered customers only)

You can choose the standard, estimation, ratio option when you complete your income tax return or by sending us a secure mail through myIR

Sending in your first AIM statement of activity on or before the first instalment due date tells us you've chosen AIM for the full tax year. You can't switch to AIM from another option during the year.

If you're a new business (or new to paying provisional tax) you can choose AIM any time before your first payment is due.

We'll use the standard option unless you choose otherwise.

Standard option

The standard option is useful if your income is steady or increases over the next year.

The calculation

  • last years residual income tax + 5%, or
  • your residual income from two years ago + 10% (only if you haven't filed last year's return yet).

Making payments

You'll usually pay three instalments, however if you're registered for GST and file six-monthly GST returns you'll only pay two instalments.

Make sure you pay on time to avoid late payment penalties and/or interest.

You can change from the standard option to the estimation option at any time, but you can't change to the ratio option or AIM during the same tax year.

Example - Megan uses the standard option to work out her provisional tax

Megan's income has been steady over the last few years. When she files her 2016 income tax return, she uses the standard option to work out her provisional tax for 2017.

Here is Megan's provisional tax calculation using the standard option:

2016 residual income tax $7,800
Plus 5% $390
2017 provisional tax $8,190

Megan can deduct the provisional tax she pays during the year from her 2017 residual income tax.

Extension of time to file your income tax return

If your income tax year ends on 31 March you'd usually need to file your income tax return by 7 July (unless you have a tax agent).

You'll know how much provisional tax you'll need to pay once you've filed your return, and you'll have time to prepare for your first instalment on the 28 August due date.

If you have an extension of time to file your income tax return, your first provisional tax payment may be due before you've filed your income tax return. In this situation, your provisional tax will be your residual income tax from two years ago plus 10%.

Our Provisional tax guide (IR289) shows you how to do these "catch-up" calculations.

Accounting income method (AIM)

When you can start using AIM

You can start using AIM as an option for provisional tax from April 2018.

If you have turnover of less than $5 million a year you can work out your provisional tax using the accounting income method (AIM). It will suit your business if:

  • your business is growing
  • you're new to business
  • you have irregular or seasonal income
  • it's hard to forecast your income accurately
  • you have accounting software or want to start using accounting software.

If you're using AIM you don't pay provisional tax until your business starts making a profit. As long as you make your payments in full and on time, there is no exposure to use-of-money interest. If your business makes a loss you can get your refund of overpaid provisional tax straightaway rather than waiting until the end of the year.

The calculation

  1. Accounting software works out your AIM profit.
  2. Your profit is taxed at your individual rate or company rate.
  3. The amount of tax is your provisional tax payment.

Your AIM profit is your total profit after your software works out if it needs to include adjustments, for example:

  • depreciation
  • private use expenditure
  • debtors and creditors
  • trading stock
  • prior year losses
  • provisions.

Making payments

On every due date you need to file a statement of activity through your software. This means we know if you have to make a payment and how much or if you're due a refund. Your statement and payment are based on your GST due dates:

  • monthly (if you're registered for monthly filing), or
  • two-monthly, if you're:
    • registered for two or six-monthly filing, or
    • not registered for GST.

Example - Masha uses the accounting income method to work out her provisional tax

Masha updates her company's accounting software with her sales and other adjustments. She files GST every two months, so her software works out her provisional payment based on a two-monthly period.

Here is Masha's provisional tax payment for April and May using the accounting income method:

Total profit for April and May $25,000
Minus total AIM adjustments $6,543
Total AIM profit for April and May $18,457
AIM provisional tax payment (profit taxed at company rate) $5,167.96

Refunds of overpaid provisional tax

Your statement of activity will let us know if you've overpaid your provisional tax for the year.

A refund can be sent to you straightaway - you won't need to file an Annual imputation return (IR4J) or wait until the end of the year to get the refund.

What happens if a statement of activity isn't filed

If you miss two statements of activity, we'll contact you to make sure there hasn't been a misunderstanding or system error. If you continue to miss filing your statement of activity you may be moved from AIM to the estimation option. This may expose you to use-of-money interest.

Interest on provisional tax

Standard, estimation or ratio option users may be charged interest in some circumstances, if the provisional tax paid is less than your residual income tax for that year. You may have to pay interest even if you:

  • paid your instalments in full and on time, or
  • didn't have to pay provisional tax.

We'll work out the interest charges once your income tax return has been filed (if you've underpaid or overpaid by $100 or less, we don't charge interest). If you've paid more provisional tax than you needed to, we may pay interest to you. However, not everyone will pay or receive interest.

Find out more about how interest rules apply

If you use the ratio option you won't pay (or receive) interest on your provisional tax instalments, but you may on your residual income tax.

If you use AIM, you won't be charged interest or penalties - as long as you pay what your software tells you to and when. If you owe tax once you've filed your return, you won't be charged interest on any residual income tax as long as you pay by the due date.

Deducting provisional tax

Remember to deduct the provisional tax you've already paid when you work out your tax to pay at the end of the year.

Estimation option (for when your income changes)

The estimation option is useful if you know your income will decrease over the next year.

The calculation

  1. Add up all the taxable income you expect to receive next year.
  2. work out the tax on this figure.
  3. Deduct any PAYE and other income tax credits you'll be entitled to.

The result is your estimated residual income tax and this is your provisional tax for the year.

Making payments

You'll usually pay three instalments, however if you're registered for GST and file six-monthly GST returns you'll only pay two instalments.

Make sure you pay on time to avoid  late payment penalties and/or interest.

Example - Jackson uses the estimation option to work out his provisional tax

Jackson expects his income to drop next year due to a downturn in his industry. When he files his 2016 income tax return, he uses the estimation option to work out his provisional tax for 2017.

Here is Jackson's provisional tax calculation using the estimation option:

2016 residual income tax $6,000
Estimated RIT for 2017 $4,500
2017 provisional tax $4,500

Jackson can deduct the provisional tax he pays during the year from his 2017 residual income tax.

Underestimating your provisional tax

You could be charged a penalty if your provisional tax estimation ends up being unreasonably low compared with your actual end-of-year tax to pay.

Avoid a penalty by keeping an eye on your income during the year. You should make a new estimate if it looks like your estimation will be too low. You can re-estimate as often as you like, right up to the date of the final instalment.

Ratio option (for GST registered customers only)

The ratio option is useful if your income tends to vary or you have seasonal income. You need to let us know you want to use this option before the beginning of the income tax year.

Only provisional tax payers registered for GST who file one-monthly or two-monthly returns can use the ratio option.

Find out if you meet the requirements in our Understanding the ratio option section.

The calculation

  1. We work out your ratio percentage by dividing your residual income tax for the last tax year by your total GST taxable supplies for the same year.
    If last year's figures aren't available, we base the ratio on the residual income tax and total GST taxable figures from the previous year.
  2. You then multiply this ratio percentage by your GST taxable supplies for the previous two months.

The result is your provisional tax for the year.

Making payments

You'll make your provisional tax payments every two months along with your GST returns.

File your GST and provisional tax return through myIR Secure Online Services

You can change from the ratio option at any time but you must let us know. If you choose to stop:

  • before the first provisional tax payment due date, you can choose to use the standard or estimation method to work out your provisional tax
  • after the first provisional tax instalment date, you're required to use the estimation option to work out your provisional tax for the remainder of the year.

Example - Oliver uses the ratio option to work out his provisional tax

Oliver is a GST registered orchardist with income that varies during the year. He decides the ratio option will be the best way to pay his 2017 provisional tax, so he applies to use it before the end of his 2016 income tax year.

We work out a ratio for Oliver to use, based on his residual income tax and his GST taxable supplies.

When Oliver completes his two-monthly GST returns, he applies the ratio to his taxable supplies. The amounts worked out are his instalments of provisional tax.

Oliver makes provisional tax instalments every two months along with his GST returns. He does this through myIR Secure Online Services.

Oliver can deduct the provisional tax he pays during the year from his 2017 residual income tax.