Lockdown factors to consider when paying provisional tax

Business owners New Zealand-wide will be feeling the immense financial strain of the Level 4 lockdown response to the Covid-19 pandemic, particularly if they have large upcoming provisional tax payments that have been projected based on pre-lockdown profits.

While the Government has rolled out some assistance to these taxpayers, including increasing the provisional tax threshold from $2500 to $5000 for the 2020-21 year, extending the ability to write off penalties and interest on overdue tax in circumstances where a business has been impacted by Covid-19, and emphasising the ability to set up an instalment arrangement to pay off tax, some of these measures are simply standard measures available to taxpayers experiencing financial hardship and are not necessarily providing any new or specialised support.

Further, the IRD (via its website) recommends that provisional taxpayers look into making an estimate of provisional tax to reduce their upcoming tax payments (for example, a reduction of the third 2020 provisional tax payment owing on May 7 for March 31 balance date taxpayers).

However, using the estimation method can expose a taxpayer to use-of-money interest if the estimate is less than what is actually earned during the year. Although interest and penalty remission options are available, in practice there are steps that a taxpayer must go through in order to receive a remission — it is not automatic or guaranteed. Further, if the taxpayer uses the estimation method for the 2020-21 year, it may be harder to argue that a tax shortfall is due to the uncertainty of Covid-19, as business as usual may have resumed part-way through the year.

Using tax pooling is another way to try to manage lumpy tax cash outflows through a combination of finance and/or drawdown options, but there are timeframe limitations on this.

Taxpayers could instead look at applying the accounting income method (AIM) for determining provisional tax payments in the 2020-21 year, to avoid the possibility of suffering use-of-money interest under the estimation method.

In order to be eligible to use AIM for provisional tax, the taxpayer must have a turnover of less than $5 million, be a company or a sole trader, and cannot be part of a consolidated group. Further, they must use an approved software provider to generate AIM returns.

The three approved software providers for AIM are Xero, Reckon and MYOB. Returns are filed two-monthly, unless the taxpayer is registered for GST on a monthly basis, in which case monthly returns are filed.

Some benefits of AIM are that the taxpayer pays tax only in a period where a profit is made, which is beneficial for businesses experiencing losses at present due to lockdown. In this case, a taxpayer may not have any tax to pay at their first provisional tax date for the 2020-21 year, rather than a liability based on the 2019 or 2020 income years under the standard uplift method. Further, the taxpayer can opt into AIM at any point during the year, and refunds can be faster if income fluctuates during the year.

However, on the flip side, taxpayers should only look into AIM if they are prepared to be extremely organised with their accounting data, as if the filing requirement is missed more than twice the taxpayer will revert to the estimation method and use-of-money interest may apply.

Further, return preparation is more complicated so there can be higher compliance costs, and tax pooling is unavailable if you are having difficulty paying income tax.

Considering the complicated nature of provisional tax rules in ordinary circumstances, the addition of Covid-19 income fluctuations can make them even more of a headache.

It is always best to reach out to your tax adviser or accountant to talk through your options so you are able to make an informed decision that could save you some much-needed cash during this challenging time.

 - Scott Mason is a tax specialist and managing partner at Findex in Dunedin.