Provisional tax can be a confusing topic for the average business owner which is compounded by the fluctuating nature of dairy farm profits from year to year.
The intention of this article is to help you better understand how provisional tax is calculated, so that when you experience a bad year following a good year (ie. what the 22/23 season has been for many dairy farmers) you understand your options for paying provisional tax.
Simply put, provisional tax is tax paid in advance. The IRD expects you to make the same profit for the following year, plus 5%, therefore they expect you to pay this tax in advance.
Dairy farmers generally have a financial year end of 31 May therefore the provisional tax payment dates are 28 October, 28 February and 28 June. The first two payment dates are during the financial year, while the last is after end of financial year.
If you have a 31 March end of financial year, the provisional payment dates are 28 August, 15 January and 7 May.
The standard method used for calculating provisional tax is the uplift method, where provisional tax is based on 105% of the previous years’ residual income tax (or 110% of the year before that if the previous year’s tax return hasn’t been filed yet).
You only become liable for provisional tax if your residual income tax (RIT) for the previous year is over $5,000 however for the purposes of this article we will assume it is over this threshold (otherwise you don’t need to worry about paying provisional tax).
Example:
For simplicity we will assume this is a company paying tax at 28%.
For example: for the 2022 financial year the company made a profit of $200,000. The tax on this is $56,000 which is well over the $5,000 RIT threshold.
Under the standard uplift method, the IRD expect you to make this same profit for the 2023 financial year, plus 5%, and they also expect you to pay this in advance.
The 2023 provisional tax will be $58,800 calculated as $56,000 multiplied by 105%.
The 2023 provisional tax is paid in three instalments at $19,600 on each 28 October 2022, 28 February 2023, and 28 June 2023.
The above method is fine if you have a business with consistent profits, however dairy farming is notoriously volatile as we have seen over the past two years.
This presents an issue for calculating and paying provisional tax, because a lot of farm owners’ and sharemilkers’ profits are down, some by up to 50% on last season, therefore paying provisional tax based on the 2022 financial year means you are overpaying tax, which is a large drain on your much needed cash.
For example: for the 2023 financial year the company makes a profit of $100,000. The tax on this is $28,000, however you have paid provisional tax of $58,800 and therefore overpaid by $30,800.
If you have a slow accountant, you may not even know about this until 6-9 months down the track which places a massive strain on cashflow.
Options to consider:
Your first port of call should be to contact your accountant now for a tax estimate for the current (2023) financial year. They should be able to calculate your profit to date, and the tax on that, less what you have already paid in provisional tax.
In some cases, you may not need to pay the third provisional tax instalment as the first two instalments cover what the tax liability is estimated to be.
There is enough time between the end of financial year (31 May) and the third instalment date (28 June) to get a good idea on what the 2023 profit will be.
Request your accountant file the 2023 tax returns before the 2024 first instalment date of 28 October 2023, so that the 2024 provisional tax is calculated based on the 2023 profit rather than 110% of the 2022 profit (catastrophic for some business’ cash flow).
There are other methods to calculate provisional tax other than the standard uplift method, however this requires careful consideration of the pros and cons of each. Discuss this with your accountant.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.