Wāhanga 3 - Te tāke moniwhiwhi me te tāke utu tōmua Part 3 - Income tax and provisional tax

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Introduction to Business

Income tax and provisional tax

Part 3

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Narrator

Kia Ora, welcome to an Introduction to Business.

This is part three of our series.

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We will talk about

• Income tax
• Provisional tax

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Narrator

In this section we’re going to look at, income tax, and provisional tax.

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Income tax

Income tax is paid on the net profit (taxable income) from your business.

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Narrator

We find most people end up in business because they’re good at what they do, not because they’re great bookkeepers or mathematicians.

At the end of each financial year an income tax return is completed, and this is how we work out if there’s any income tax to pay.

Income tax is paid on the net profit, or taxable income, of your business.

The basic calculation is your sales, less your expenses, equals your net profit.

Note, that if you’re registered for GST, you take the GST off your sales and expenses when you do your income tax.

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Income tax rates

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So far in this series we’ve been looking at the income minus sales net profit formula.

We’ve looked at common kinds of expenses and how we treat these if there are business and private use components.

Once we’ve determined our net profit, how do we work out the tax?

New Zealand has progressive tax rates.

The rates increase as your income increases.

These are the tax rate bands.

Each individual or partner in a partnership has a portion of their income taxed at the lower rate.

Companies have a set company tax rate, as they have other ways of making distributions.

The company tax rate is 28 percent.

Let’s look at an example.

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Income tax calculation

For an individual or sole trader 1 April to 31 March.

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Narrator

In the original example back at slide 1, we had a sole trader whose gross sales were 125,000 dollars, expenses were 50,000 dollars, which created a net profit, or taxable income, of 75,000 dollars.

Let’s use those same figures here.

The first 14,000 dollars is taxed at 10.5 percent.

The amount between 14 and 48,000 is taxed at 17.5 percent.

The amount between 48 and 70,000 is taxed at 30 percent.

And any amount over 70,000 is taxed at 33 percent.

Based on a taxable income of 75,000 dollars, the tax component is 15,670 dollars.

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Provisional tax

Provisional tax is a way of paying your income tax as you go. It applied when your residual income tax (RIT) is more than $5,000.

A choice of 4 options:

• AIM - pay as you go
• Standard
• Estimation
• Ratio

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Narrator

Provisional tax is a way of paying your tax throughout the year.

Similar to how a salary and wage earner has PAYE deducted throughout the year.

Once you’ve completed your first tax return, and we’ve calculated how much tax you need to pay, we can also work out if you’ll become a provisional taxpayer.

To become a provisional taxpayer, you need to have a tax bill in the prior year of more than 5,000 dollars.

This was 2,500 dollars but has been increased as part of COVID-19 changes.

If your residual income tax or your tax bill was less than 5,000 dollars, you’ll continue to pay your tax as a single lump sum each year.

If your residual income tax or your tax bill was more than 5,000 dollars, you’ll become a provisional taxpayer.

There are 4 options for provisional tax.

AIM, or the Accounting Income Method, is a pay as you go option and can be done through certain software.

The standard option, which is what we’ll focus on today.

And there is the estimation option, where you can estimate what you think your tax bill will be, and pay instalments based on your estimate.

These can be especially useful if you had a great prior year, but you expect this years’ profits to be much less.

Be aware there may be penalties and interest if your estimate is lower than your end of year bill.

The final option is the ratio option.

You generally would need to have been in business, and GST registered, for 2 years before you can use this, as we use your income tax return and 12 months of GST returns to work out the ratio to apply to determine payment amounts.

Let’s have a look at the standard option example.

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Provisional tax option

Standard option

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Using our sole trader example, we’ve worked out that the tax for year 1 in this example is 15,670 dollars, and as this is over the 5,000 dollar provisional tax threshold, this sole trader is going to be a provisional taxpayer for year 2 of business.

Provisional tax payments are made in 3 instalments.

They are calculated by taking the residual income tax from the prior year, and multiplying it by 105 percent.

The 5 percent uplift assumes that the business has an increase in profit year after year.

In this scenario we take the year 1 tax due of 15,670 dollars, multiply this by 105 percent, which equals 16,453 dollars.

We then divide this by 3, as there are 3 provisional tax payment dates in each year.

Two payments of 5,484 dollars, and a final payment of 5,485 dollars.

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Provisional tax due dates

Standard option

A line runs from left to right on the screen. The line is split into 3 sections indicating a timeline: Year 1, Year 2 and Year 3.

31 March is displayed underneath the Year 1 and Year 2 border, and again under the Year 2 and Year 3 border. These indicate the end and start of the tax years.

Start of business is shown on the timeline in the Year 1 section, indicating the business started sometime during year 1.

Tax return due 7 July is shown after, but close to, the start of the Year 2 section. This shows that the Year 1 tax return is after the start of Year 2.

Year 1 tax due $15,670 7 February is shown close to, but before the end, of the Year 2 section. This shows that the taxes for Year 1 are due to be paid near the end of Year 2.

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Let’s plot these on a timeline.

Here is our 3 year timeline.

We start business at some time in year 1.

The end of the financial year, being 31 March.

We prepare our income tax return, and file this by the due date of 7 July that year.

If you have a tax agent working for you, they may have an extension to this date.

Our tax for year 1 is 15,670 dollars, due by 7 February in year 2.

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Provisional tax due dates

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The same timeline remains. The 3 dates disappear from the timeline, replaced by 3 new dates showing provisional tax instalment dates.

Instalment 1, $5,484, 28 August is shown about one-third of the way along the Year 2 section.

Instalment 2, $5,484, 15 January is shown about two-thirds along the Year 2 section.

Instalment 3, $5,485, 7 May is shown close to, but after, the start of the Year 3 section.

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Let’s overlap the 3 provisional tax due dates onto our timeline.

You can see our 3 provisional tax due dates of 28 August, 15 January and 7 May.

You’ll often hear the myth that your first year of business is tax free.

Which is technically correct, as you don’t pay tax [emphasised]in your first year of business, but you do pay tax [emphasised]for your first year of business, but this is paid in year 2.

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Provisional tax due dates

Standard option

The same timeline remains

Year 1 tax due $15,670 7 February is shown again near the end of the Year 2 section. It is between the Instalment date 2 and Instalment date 3. This shows the end of year tax for Year 1 is close to Year 2’s second provisional tax instalment date.

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Year 2 is often the hardest as you have a lumpsum to pay for last years’ tax, and you are preparing the current year tax by way of provisional tax payments.

This is why it’s very important to plan and budget for tax.

Make sure you are putting amounts aside for these future obligations, and to make the second year of business a bit easier.

You will start to fall into a routine, making your 3 provisional tax payments, then once the return is filed it will work out if you’ve paid too much, or too little for that year

If you have not paid enough, there’ll be a payment due on 7 February each year.

Or if you’ve paid too much, then a refund will be issued.

If you have an accountant, you’ll usually have until 7 April to pay any end of year tax bill.

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Other tax responsibilities

• Goods and services tax (GST)
  Threshold $60,000
• Employing people
  Employee or contractor
• ACC
  Business industry code (BIC)
• Penalties and interest
  Late filing and paying

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Narrator

We’ve covered a huge amount of content in this series.

As a business owner there are a few other responsibilities to be aware of, such as GST.

If your turnover goes over 60,000 dollars, you’ll need to register for GST.

Please note, turnover is your sales, not your net profit.

If you employ staff you’ll need to register as an employer and have responsibilities around leave entitlements, PAYE deductions etcetera.

As mentioned earlier ACC, will bill you directly.

It would pay to make contact with them to get an idea of their levies based on your industry.

Inland Revenue charges penalties and interest if returns are not filed or paid on time.

If you’re having difficulty, please contact us, as we may be able to set up payment plans.

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Online tools

myIR, guides, demos, and information available on our Inland revenue website.

www.ird.govt.nz.

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We have a huge range of tools available online that I have talked about today, such as, the cashbook template, logbook and the deprecation rate finder and calculator.

There are also demos on how to file returns online.

If you have not registered your business for a myIR account, I suggest you do this first.

It makes communicating with us, or registering for GST, or as an employer, much easier.

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Tax relied – COVID-19 Coronavirus

• If you’ve been affected by the downturn in business due to COVID-19 coronavirus, we have a range of ways to help.
• Talk to your tax agent, visit ird.govt.nz/covid19, or phone 0800 473 566 for more information.

Go to ird.govt.nz/covid19 for more information

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Our COVID-19 provisions are changing very fast.

We’ve tried to have this presentation accurate to the day it was written, but things do change.

Please go to our COVID-19 link on our website for the most up-to-date information.

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Remember our key messages

• Inland Revenue is here to help you
• Good records are key for a successful business
• Planning and budgeting helps you get it right
• There are lots of places you can find useful information

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I can’t stress these key messages enough.

We’re here to help.

If you are unsure of something, make contact, send us a web message through your myIR account.

Good records are the key to good business.

You know where you’ve been and where you’re at, being in business is a journey that keeps changing.

Plan, and budget for tax payments.

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What’s next?

An email with links to, IR’s website and a survey.

Some useful links:

• www.ird.govt.nz
• www.mbie.govt.nz
• www.acc.co.nz
• www.nzbn.govt.nz
• www.businessmentors.org.nz

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Narrator

Hoo, we’ve reached our final slide.

Check out these websites for further business help.

Thank you for listening today, and remember, you can go back and replay this seminar, and skip to the bits you want to go over again.

Thank you for joining me, and enjoy your journey into business.

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