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Provisional Tax: What Business Owners Need to Know
As an employee, taxes are relatively straightforward:
- You earn a regular salary or hourly wage.
- Tax is automatically calculated and deducted by your employer based on your expected income.
- What lands in your bank account is yours to spend.
For business owners, it’s not so simple. Predicting your tax obligations throughout the year can be tricky because your business income—and by extension, your personal income—can fluctuate significantly.
One of the most common questions we get asked at Mondo Advisory is, “How does provisional tax work?” So, we’ve put together this guide to break it all down for you.
How Business Owners Pay Tax
At its core, income tax for business owners is paid in one of two ways:
- In a lump sum – typically 12 months after the end of your financial year.
- In instalments – spread throughout the financial year.
If your residual income tax is under $5,000, you’ll generally pay it in one lump sum. But if your residual income tax is over $5,000, the Inland Revenue Department (IRD) requires you to pay in instalments. This system is called provisional tax.
Provisional Tax, Terminal Tax, and Income Tax – What’s the Difference?
Income tax is a broad term, but the way it’s paid is where different names come into play:
- Provisional Tax refers to income tax paid in instalments during the year. It’s not a separate tax, just a way to spread out your payments.
- Terminal Tax is the balance of your income tax owed after provisional tax payments. It’s usually due after the end of the tax year on the 7th of April (or 7th February if you don’t use a tax agent) and is the final settlement of the year’s tax obligations
- PAYE (Pay-As-You-Earn) applies to employees, where tax is deducted automatically from their wages.
For most businesses, the tax year runs from 1 April to 31 March, aligning with the financial year.
How Much Provisional Tax Do I Need to Pay?
By default, IRD calculates your provisional tax using the standard uplift method, which adds 5% to last year’s residual income tax. If you have not filed your previous year’s tax return, a standard uplift of 10% will be based on your residual income tax from two years prior, until the return is filed.
There are other methods to calculate provisional tax, but the standard method is the most common. Another method is the estimation of your provisional tax. Simply put, this involves estimating the total taxable income you anticipate receiving and calculating the estimated residual income tax, which forms the basis for your provisional tax payments. You can re-estimate your provisional tax as often as needed up to third (final) instalment date, but it is crucial to ensure that your estimate is fair and reasonable to avoid penalties. If your estimate is too low, you may incur use-of-money interest and potentially face shortfall penalties if the estimate is deemed unreasonably low.
What If I Don’t Pay Enough Provisional Tax?
It’s common for the standard uplift method to result in either underpayments or overpayments.
- If your tax payments during the year don’t cover your actual income tax, you’ll have a terminal tax balance to pay.
- If you’ve overpaid, you’ll receive a refund after filing your tax return.
When Do I Pay Provisional Tax?
Provisional tax is typically paid in three instalments, but the exact dates depend on your balance date and GST filing frequency.
For most business owners with a 31 March balance date, the key dates for the 2025 tax year are:
- 28th August 2024 – First instalment
- 15th January 2025 – Second instalment
- 7th May 2025 – Third instalment
- 7th February 2026 or 7th April 2026 – Balance due (terminal tax)
For GST-registered businesses using the ratio method, provisional tax may be paid in six instalments throughout the year.
Tax in Your First Year of Business
Yes, you must pay tax on income earned in your first year of business. However, your first payment isn’t due until after you’ve filed your tax return for that year.
For example:
- If your financial year ends on 31 March 2024, your income tax won’t be due until 7th April 2025 (or 7th February 2025 if you don’t use an accountant).
Managing Provisional Tax
Accurate income forecasting is key to managing provisional tax effectively. Regularly review your financial performance and adjust your tax estimates as needed.
At Mondo Advisory, we help business owners navigate provisional tax and maintain healthy cash flow. If you’re feeling overwhelmed or need guidance, we’re here to help. Let’s make tax less stressful so you can focus on growing your business.
Need Help?
Get in touch with Mondo Advisory today to learn how we can simplify your tax planning and help you take control of your finances.