Understanding Provisional Tax and How it Works
Ever wondered how people manage to pay their taxes without facing financial strain? Paying a large lump sum can be daunting, but New Zealand’s provisional tax system helps by breaking payments into manageable installments throughout the year. This helps prevent any unwanted surprises when your tax bill is due. In this guide, we’ll explore the essentials of provisional tax, including who is required to pay it, how it works, and the options available to you.
What is Provisional Tax?
Provisional tax is a system in New Zealand designed to help taxpayers pay their income tax by paying in installments throughout the year instead of paying one large bill at the end of the year. This system ensures taxpayers meet their tax obligations while alleviating some of their financial burdens.
Who Needs to Pay Provisional Tax?
You may need to pay provisional tax if your residual income tax (RIT) from the year prior exceeds $5,000. Before the 2020 tax year, the threshold was $2,500.
Your RIT is your final income tax for the year is the total tax owed minus any PAYE and eligible tax credits, excluding Working for Families Tax Credits.
Examples of taxpayers who often pay provisional tax include:
- Self-employed individuals
- Contractors and freelancers
- Rental property owners
- Partners in a business
- People with overseas income
Additionally, some employees may need to pay provisional tax if their income tax was underpaid due to:
- Incorrect tax codes for PAYE, interest, or dividends
- Lump sum payments with insufficient tax deductions
- Employee share scheme income
Changes Due to COVID-19
To support small taxpayers, the provisional tax threshold was increased from $2,500 to $5,000. This change allows those with provisional tax payments below this threshold to defer payment until 7 February following their filing year, easing compliance costs and improving cash flow.
How Provisional Tax Works
Provisional tax is payable in the following tax year after your income tax return is filed. For example, if your 2023 tax return shows a residual income tax of more than $5,000, you’ll need to make provisional tax payments in 2024.
New Business Owners:
If you start a business, you won’t have to pay provisional tax in your first year. However, you’ll still need to pay tax on your profits.
To avoid cash flow issues in the second year, new business owners can:
- Make voluntary tax payments during the first year
- Set money aside for tax obligations
- Take advantage of early payment discounts (visit IRD’s website for details)
Calculating Provisional Tax
There are four main methods for calculating provisional tax:
1. Standard Option (default option)
Your provisional tax for the new year is last year’s RIT + 5%.
Example: If your 2023 RIT was $10,130, your 2024 provisional tax would be:
$10,130 + (5% of $10,130) = $10,636
If you haven’t filed your return yet, your tax is based on RIT from two years ago + 10%
Source: IR289 – Provisional Tax Guide (IRD)
2. Estimation Option
You estimate your expected income and tax for the next year and pay based on that.
Example: If you expect to earn $70,000 in 2024, with estimated tax of $14,020 and credits of $2,000, your provisional tax would be:
$14,020 – $2,000 = $12,020
Important: If you underestimate, you may be charged interest or penalties.
Keep in mind that choosing the estimation option prevents you from using another calculation option during the same tax year. You are allowed to re-estimate your provisional tax as much as you like, up until your final instalment date, which then your estimate becomes finalised.
Source: IR289 – Provisional Tax Guide (IRD)
3. Accounting Income Method (AIM) Option
The AIM option bases provisional tax payments on your profits. You only pay when making a profit—no payments are required if you’re not.
- Qualifying for AIM:
AIM is available to businesses with a turnover under $5M, except in years when the balance date changes. - AIM-Capable Accounting Software:
Using AIM requires approved accounting software to calculate and report provisional tax. - Provisional Tax Calculation & Payments:
Provisional tax is calculated based on profits and paid in line with GST due dates. - Overpayments & Refunds:
Tax may be overpaid in the event of a profit drop. Overpaid tax can be refunded immediately if requested in the Statement of Activity.
4. Ratio Option
Ideal for businesses with fluctuating income, as tax payments are based on a percentage of GST taxable supplies.
- Qualifying for the Ratio Option – Businesses must be GST-registered for at least one full tax year, have RIT over $5,000, and file GST monthly or two-monthly.
- Before Using the Ratio Option – the IRD must be informed before the tax year begins should you decide to use the ratio option. The ratio percentage will be calculated based on the information from your income tax and GST returns.
- Ratio Percentage Calculation – Determined by dividing the previous year’s RIT by total GST taxable supplies; Inland Revenue calculates and informs businesses of the percentage.
- Calculating Provisional Tax – The ratio percentage is applied to GST taxable supplies in each return for two-monthly filers or every second return for one-monthly filers.
- Adjusting the Ratio Percentage – Businesses can request adjustments if selling fixed assets worth at least $1,000 or 5% of their taxable supplies to prevent overpayment.
Ceasing the Ratio Option – Businesses can opt out anytime but must stop if they deregister for GST, miss filing deadlines, or their ratio percentage falls outside 0-100%.
Source: IR289 – Provisional Tax Guide (IRD)
Provisional Tax on One-Off Untaxed Income
- If untaxed income pushes Residual Income Tax (RIT) over $5,000, the taxpayer becomes provisional.
- RIT that is over $60,000: Use-of-money interest applies from the third instalment (P3) if unpaid.
- RIT under $60,000: No interest if paid by the terminal tax date.
- Inland Revenue applies the standard method unless the taxpayer chooses estimation.
- If RIT drops below $5,000 next year, they are no longer provisional unless they opt in.
- Late or underpaid provisional tax may incur penalties.
- Tax pooling is not covered in this ruling.
Choosing the Right Option
Selecting the best provisional tax method depends on how predictable your income is. If your earnings fluctuate, AIM or the Ratio Option may work better than the Standard or Estimation options. However, if you want a simple, predictable system, the Standard Option might be the best choice.
IRD Guide to Provisional Tax (Links to an external site)
When to Pay Provisional Tax?
Your payment schedule depends on the option you use or whether you are registered for GST:
- Standard & Estimation Methods: Payments are due on 28 August, 15 January, and 7 May (for standard GST filers).
- AIM Method: Due alongside your GST filing dates (monthly or bi-monthly).
- Ratio Method: Paid in 6 instalments throughout the year.
GST Filing Frequency | Provisional Tax Instalments |
Not registered for GST | 3 instalments |
Monthly or two-monthly GST filing | 3 instalments |
Six-monthly GST filing | 2 instalments |
Using the ratio option | 6 instalments |
For a standard 31 March balance date, payments are due:
- 28 August
- 15 January
- 7 May
If you file GST six-monthly, payments are due:
- 28 October
- 7 May
If you use the ratio option, payments are due every two months.
How to Pay Your Provisional Tax
Payments can be made via:
- Direct debit in myIR
- Credit/debit card at IRD’s payment portal.
- Internet banking (New Zealand banks have a “pay tax” option)
When paying, include:
- Your IRD number
- The tax account type (e.g., provisional tax)
- The tax year the payment applies to
Interest on Provisional Tax
You could be charged or paid interest depending on the payments you make, such as underpaying, paying late, or paying too much. This is determined by the IRD once you have filed your tax return.
When Is Interest Charged?
Interest is typically charged in the following situations:
- If you pay your provisional tax late or underpay, interest will be applied from the day after the missed payment was due.
- If you underestimate your provisional tax using the estimation option, interest may be charged on the difference between your estimated and actual residual income tax.
- If you owe more than $100 after your end-of-year tax due date (7 February or 7 April with a tax agent extension), interest may be applied.
- Interest does not apply when underpaying by $100 or less.
When Can You Receive Interest?
In some cases, if you overpay your provisional tax, Inland Revenue may pay you interest. However, this depends on the payment method you choose:
- If you use the Accounting Income Method (AIM), you will not receive interest on overpaid provisional tax.
- If you use the estimation method and overestimate your tax, you may be eligible to receive interest.
- Interest does not apply when overpaying by $100 or less.
Interest rules for each option
Each provisional tax option has different interest rules:
- AIM Option: Interest is charged on late or underpaid tax from the day after the instalment due date.
- Ratio Option: No interest is charged if payments are made on time, but late or underpaid instalments may incur interest and penalties.
- Standard Option:
- If your residual income tax (RIT) is less than $60,000, interest is charged from the day after your end-of-year tax due date.
- If your RIT is $60,000 or more, interest is charged from the final instalment date, assuming all prior payments were made on time.
- Estimation Option: Interest may be charged from the first provisional tax instalment if you underestimate your tax.
Starting a New Business? Here’s What You Need to Know
If you make a net profit in your first year of business, you will owe tax on that income. Since you don’t pay provisional tax in your first year, setting aside funds or making voluntary tax payments can help manage cash flow. You may even qualify for an early payment discount.
If you are a new business owner and expect to have a residual income tax of more than $5,000, special rules apply:
- Interest may be charged from the day after your first instalment was due if you underpay.
- If your RIT is $60,000 or more, interest will be calculated from the final instalment date.
Find out more
For more details, visit one of the guides provided by the IRD.
Provisional tax guide IR289 – IRD Website
GST and provisional tax IR235 – IRD Website
Provisional tax Summary IR316 – IRD Website
Need Help with Accounting? We’re Here for You!
Provisional tax helps you manage cash flow and avoid a large tax bill at the end of the year. The best method depends on your income stability and financial situation. If you’re unsure, you may consult with us at DAD Accountant to provide any clarification on your specific situation.
February 27, 2025