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Provisional tax changes
A recent change to the provisional tax rules in New Zealand means taxpayers, mainly businesses, that are growing and previously needed to increase their provisional tax payments above the IRD minimum requirement so that they paid enough to cover their actual tax and avoid IRD interest, will no longer have this pressure put on their cashflow.
Note, these changes are effective from the 2018 tax year.
What is the change?
The basic rule is that taxpayers who pay all but their final instalment of provisional tax based on standard uplift (what IRD is expecting based on the last tax return filed) will not be charged interest until after the date of final instalment.
The typical situation for a company with three provisional tax instalments will now be to pay the first two instalments based on the last tax return filed, and at the third instalment the business will catch up (if applicable) to ensure the total provisional tax paid covers the actual profit for the year. There is no interest cost associated with this delay.
It means for businesses that are growing, in some cases the first two instalments may be lower, with a higher instalment at the third instalment date. So cashflow planning and being aware that a larger tax payment is coming are more important than ever. It is wise to keep on top of this during the year. We suggest you have Hayes Knight calculate your tax payments as usual so you know the amount you need to plan for. But you can hold onto those funds for another 8 months and use that cash in your business with no interest cost.
Some of the changes impact provisional tax decisions across your group, so if we do not act for some entities in your group, decisions could be made by those entities that impact the entities we advise you on. Whilst we would obviously prefer to act for any other entities, if this is not possible the different advisors need to be discussing tax situations before any provisional tax estimates are lodged with IRD.
Issues to watch
- If a taxpayer estimates its provisional tax, this can result in an associated entity (company, individual or trust) not being able to use the new rules, meaning interest could be charged unexpectedly.
Example – husband and wife have a company and a trust, the trust owns 98% of the shares in the company. The company is growing and the directors have decided to take advantage of the new provisional tax rules, they pay P1 & P2 based on standard uplift and at P3 they make a larger tax payment to cover the tax for the year. The trust owns a residential rental property which was sold in the previous year, the provisional tax has been estimated at nil. Depending on the dates and amounts, the trust having been estimated to nil could have an impact on the company’s provisional tax position and mean the company is charged interest even though it paid tax based on standard uplift at P1 & P2.
- There is a general rule to prevent abuse/manipulation of the new rules. If an arrangement is set up to manipulate the amount of tax to defeat the intent of the interest rules, IRD can charge interest regardless.
Example – moving income between taxpayers on alternating years so that no taxpayer needs to pay provisional tax and extra time to pay is gained by the manipulation of income.
There is another change that impacts smaller taxpayers. Any taxpayer (company, trust or individual) with Residual Income Tax below $60,000 for the year will not be charged interest at all, provided they have paid provisional tax based on standard uplift (based on last tax return filed) and pay their terminal tax on the due date. Residual Income Tax (RIT) is the tax for the year less any tax deducted at source (eg. PAYE, RWT). If you would like to know what your Residual Income Tax is, this figure is identified on your tax return. For those in the know, this is what we call a “safe harbour” taxpayer. Previously only individuals could be “safe harbour” but under the changes, companies and trusts will also be safe harbour if they are below the $60,000 threshold.
Here are some examples to demonstrate how the new rules differ to the old rules:
2016 Tax (RIT) $900,000
2017 provisional tax payments made (based on standard uplift – 2016 tax return):
28 August 2016
15 January 2017
Then in April 2017, the company realises it has grown significantly in the 2017 financial year, its management accounts are showing a profit of $4,600,000, meaning it expects its tax bill to be $1,288,000.
On 7 May 2017, the third provisional tax instalment for the 2017 year, the company makes a payment of $658,000 so it has paid enough tax to cover its profit for the year.
When the company’s tax return is filed, it shows tax (RIT) of $1,288,000.
There is no terminal tax due as the company has paid its full tax for the year.
But once the 2017 tax return is filed showing tax of $1,288,000, IRD charges interest of approximately $9,500 since the first instalment date. This is based on the company having the use of the funds from the date of the first and second instalments to the date of the third instalment when they caught up.
Assume the same facts as above but everything happens a year later, so that the new rules for interest and provisional tax apply.
Again, there is no terminal tax due as the company has paid its full tax for the year.
The beauty of the new rules is that the company has paid its first two instalments based on standard uplift, and by the third instalment it has paid its full tax for the year, so no interest is charged by IRD.
A company owns a rental property which it has owned for approximately 20 years. The company used to claim depreciation on the buildings back when it was permitted (up to the 2011 financial year).
In the 2016 year the company had a small profit of $6,500 which resulted in tax to pay (RIT) of $1,820.
As the company’s tax (RIT) for 2016 was below $2,500, it was not required to pay provisional tax in the 2017 year so it made no provisional tax payments on 28 August 2016, 15 January 2017 or 7 May 2017.
In February 2017, with the property market booming, the company was unexpectedly approached with a large offer to purchase the property. The directors decide to accept the offer with settlement taking place on 15 March 2017.
The directors did not discuss the sale of the property with their tax adviser/accountant and the directors were unaware of the looming tax liability and potential interest charge by the IRD.
When the accounts and tax return were prepared in September 2017, the directors were made aware that $24,000 in tax was required to be paid for the 2017 financial year on the historic depreciation claim (known as depreciation recovered).
Even though the company was not required to pay 2017 provisional tax and made little profit to speak of until the property was sold in the final month of the 2017 financial year, IRD interest is still charged dating back to the first provisional tax instalment date. Assuming the company pays its tax when it finds out on 30 September 2017, total interest charged would be approximately $1,450.
Assume the same facts as above but everything happens one year later, so that the new rules for interest and provisional tax apply.
As the company was not required to pay provisional tax, and it is a “safe harbour” taxpayer because its tax is below $60,000 the IRD will not charge any interest provided the company pays the terminal tax on the due date.
There are many factors to consider about the changes. The above are just a couple of examples of the impact and does not cover every scenario. If you would like to discuss your specific circumstances, please contact your Hayes Knight adviser.