Understanding Provisional Tax

Provisional tax is basically like pre-paying your income tax in instalments, instead of getting one big bill at the end of the year.

If your last tax bill was over $5,000, the IRD assumes you’ll earn roughly the same this year and expects you to pay tax as you go, usually in two or three instalments throughout the year.

It’s designed to help smooth out your cashflow and avoid nasty surprises come year-end.

Provisional tax is based on what the IRD thinks you’ll earn, not your actual income right now. So if your income rises or falls, your payments might not line up perfectly.

You don’t need to apply for provisional tax – it happens automatically. The IRD looks at your residual income tax (RIT), which is the tax your company, trust, or you personally still owe after any tax credits.

If your RIT is over $5,000, the IRD will issue provisional tax instalments for the following year.

Understanding this threshold and the instalment dates helps you plan your cashflow.

There are several methods for calculating provisional tax instalments. The standard method is the most common, which is based on your most recently filed tax return and is best for those with stable or increasing income.

Other methods such as the estimation method may be suitable if your income is more variable, so please contact us to discuss if this may apply to you.

The standard method works like this:

• If your latest return is filed, they take the previous year’s RIT and add 5% to allow for a small increase.
• If your latest return isn’t filed, they use the RIT from the year before and add 10%, since it’s an older figure and a bigger buffer is needed.

In short:

• Latest year filed: last year’s tax + 5%
• Not filed yet: tax from two years ago + 10%

Keeping track of your income through the year helps you compare it to the IRD’s estimate and adjust if needed.

Provisional tax payments are usually due in two or three instalments throughout the year, depending on your payment option and income.

For businesses on a standard 31 March balance date and using the standard method, the dates are:

• First instalment: 28 August
• Second instalment: 15 January
• Third instalment: 7 May

Unless you have 6-monthly GST filing, then the dates are:

• First instalment: 28 October
• Second instalment: 7 May

Paying on time helps avoid interest and penalties, and keeps your cashflow predictable. Setting reminders or marking your calendar is a simple way to stay on top of these dates.

Terminal tax is the final income tax payment for a tax year.

It’s the balance of tax still to pay once provisional tax payments – if any – have been taken into account.

For example, if your actual profit was higher than expected, provisional payments might not have covered the full amount. The shortfall becomes your terminal tax.

If no provisional payments were made, the entire year’s tax bill will be due as terminal tax.

It’s called “terminal” because it’s the last payment for that year, but it’s still due by the IRD deadline. Late payment can trigger interest and penalties, so it’s important to plan ahead.

Residual income tax (RIT) is the tax your company, trust, or you personally still owe after any payments or credits have been applied.

Think of it as the leftover tax at the end of the year. Even if your company has paid some tax during the year – for example through provisional tax or resident withholding tax on interest income – there might still be an amount left to pay. That’s your RIT.

This number determines whether your company will need to make provisional tax payments next year. If your RIT is over $5,000, the IRD will automatically issue provisional tax instalments.

Knowing your RIT helps you plan cashflow and avoid interest or penalties for underpayment.

UOMI is interest charged or paid by Inland Revenue when tax is underpaid or overpaid. Interest on underpayments isn’t technically a penalty, but rather compensation for using the government’s money outside the due dates.

If you underpay provisional tax or pay late, Inland Revenue may charge UOMI from the due date, or from the terminal tax date if you qualify for the safe harbour. If you overpay and meet certain conditions, IRD may pay you credit interest.

Staying on top of your provisional tax payments and meeting due dates is the best way to avoid UOMI charges.

Safe harbour is a rule that can protect companies, trusts and individuals from IRD interest charges on underpaid provisional tax.

You qualify automatically if:

1. Your residual income tax is $60,000 or less, and
2. You calculate your provisional tax instalments using the standard method.

The requirement to pay instalments “in full and on time” no longer applies – if you’re a safe harbour taxpayer, you won’t be charged interest until your terminal tax date.

There’s no need to ‘apply’ for safe harbour – if you meet the criteria, the IRD applies it automatically.

This means that even if your final income is higher than expected, you won’t be charged interest on the extra amount, as long as the safe harbour rules are met.

You’ll still need to pay the balance as terminal tax by the due date, but without the extra interest cost.

If you, your company, or your trust don’t meet the safe harbour criteria, the IRD can charge use-of-money interest (UOMI) on any underpaid provisional tax.

This interest starts from the due date of each provisional tax instalment, not just from the terminal tax payment at year-end.

The IRD’s interest rate is higher than what you’d typically earn at the bank, so it can add up quickly.

The good news is there are ways to reduce or remove some of that interest. The most common method is tax pooling, which we cover in the next FAQ.

If you pay provisional or terminal tax late – or pays less than the amount due – the IRD charges interest from the day after the payment was due.

They can also apply late payment penalties, which start small but keep adding up the longer the balance remains unpaid.

Even if the underpayment was unintentional, the IRD still applies interest on the shortfall.

The good news is there are options to reduce or remove some of these costs, including tax pooling.