Over the years, we have found that one of the most common areas of confusion for clients is the provisional tax system, and when interest and penalties may apply. In this article, we address the frequently asked questions and try to make some sense from the confusion.

We find that a great starting point is to think of provisional tax as a progress payment of the tax payable on your current year’s income. As the current year’s income cannot be calculated until after the end of the year, provisional tax for the current year is usually based upon last year’s income, although in some cases it must be estimated.

When do I become a provisional taxpayer?
It is probably easier to answer this question by asking when am I not a provisional taxpayer! If last year’s residual income tax (after taking into account all your tax credits in the nature of PAYE, withholding tax, resident withholding tax, imputation credits, etc.) was under $2,500 you do not generally have to pay provisional tax this year.

When do I pay?
This progress payment is paid three times a year. For most taxpayers these will be July, November and March, so most will have their 3rd instalment of 2006 provisional tax due for payment on 7 March 2006. If it is not paid, or if it is short paid then you can be faced with extra penalties and interest.

What happens if I don’t pay?
If you short pay your provisional tax it can, in some cases, have very severe interest consequences. If your final tax bill is much greater than what you have paid as provisional tax then there are times when you will have to pay interest backdated to start from when the first instalment of provisional tax was due. This can happen even when the first instalment was correctly calculated and paid in the first place. It can even occur when unexpectedly large profits arise between the 8th and 31st March which is after the time when the final instalment of provisional tax was paid.

Short payments may also incur penalties if insufficient care was taken when estimating. But you are not penalised with not having taken reasonable care if you have over-paid your provisional tax.

How can I avoid the penalties and interest?
The answer is simple – by paying your taxes on time! If you are one day late then a 1% penalty is added. If you still haven’t paid after a week then a further 4% penalty is added, and every month after that a further 1% penalty is added. All this is in addition to interest.

The interest rate on unpaid tax is 13.08%, whereas in some cases if you have overpaid you will get interest at 5.71% paid to you. Any interest you get is taxable, but some conditions must be met before any interest you pay is deductible.

Estimating provisional tax
Instead of calculating your provisional tax based upon last year’s tax, you can make an estimate of the amount as long as you do it before the date to pay your third instalment. The obvious advantage being that you can avoid paying too much if, for example, your income is down this year. But if you short pay through estimating too low, then you will also incur interest payable to the tax department.

If you think your provisional tax is too low it is usually better to pay extra amounts, rather than estimating. Estimating can lead to a liability to pay interest whereas paying extra amounts does not.

Conclusion
Provisional tax is simply paying your current years taxes on a pay as you go basis, in three separate instalments – July, November and March. At the end of the year when you prepare your tax return you will get a credit for the provisional tax paid. You can estimate your tax if your circumstances have changed from the previous year, but beware – there are penalties for getting it wrong. So, if you have any concerns about meeting your tax payments you need to see your accountant who has the facility to make payment arrangements with the tax department and to negotiate penalties.

_{All information in this newsletter is, to the best of the author’s knowledge, true and accurate. No liability is assumed by the author or the publisher for any losses suffered by any person relying directly or indirectly upon this newsletter. You are advised to consult professionals before acting upon this information}

Greg Eden |Eden Associates Ltd

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