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Accounting 101: Tax, Terminal vs Provisional

Welcome to our new series: Accounting 101

In this series we will help you understand the Accounting Terms that don't sound fun and generally go over people's heads! Let us know if you are interested in a particular topic and we can break it down and help explain it for you! This is Accounting 101 - no topic is too small. After it all, it begins with the basics!

TAX: Terminal vs Provisional

a compulsory contribution to state revenue, levied by the government on workers' income and business profits, or added to the cost of some goods, services and transactions.

.....even the definition is scary! Tax is a word most shudder at, but how many people and business owners really understand Tax. Maybe we can turn that 'shudder' into a small shrug with an air of confidence.

In New Zealand, the standard dates for the financial year are 1st of April start and 31st of March end. All income and expenses that occurred in that 12 month period are captured, and the profit made in this period will be the basis of the tax to pay for that entity. (Farmers are a bit special though, their financial year is from 1st June to 31 May, to work in with the farming season)!

Throughout the first year of business operations there is no tax to pay, as the profit or loss is unknown until financial year end. Once the 31st of March is passed and the annual accounts are prepared, it will be known firstly what terminal tax to pay on that profit, and secondly what provisional tax that will need to be paid for the following financial year.

Terminal Tax is the tax paid retrospectively; based on the year just been. There is one terminal tax amount, and this will be the last tax instalment for a finished financial year.

Provisional Tax is the tax paid in advance for the year currently in progress, and is paid in three instalments. Essentially, it is the IRD’s way of collecting tax as a business earns, similar to PAYE on wages. Provisional tax is only required if the previous years total tax was greater than $2,500, and is based on the previous years tax plus 5%. 

Worked Example

ABC Company earns $100,000 profit in its first year ended 31 March 2019. Tax on this at 28% (the NZ company rate) would be $28,000 and this would be ABC’s 2019 Terminal Tax. This isn’t due til the following April 2020, a year later.

For the Provisional Tax instalments in preparation for the year ended 31 March 2020, the IRD require 1.05 times prior years tax to be paid throughout the current year, as they like to allow for the business to do a bit better than last year!

So, $28,000 x 1.05 = $29,400 for the total 2020 Provisional Tax. This amount is broken into three instalments of $9,800 and are due in August 2019, January 2020  and May 2020.

What if ABC Company makes LESS than expected for the year ended 31 March 2020?

For example, if ABC only made $50,000, then the tax on that would be $14,000. Because they have overpaid tax in the form of Provisional instalments ($29,400) they get a 2020 Terminal Tax refund of $15,400.

What if ABC Company makes MORE than expected in 2020?

If for example ABC made $150,000 profit, the tax would be $42,000 less the Provisional Tax amounts already paid of $29,400, so ABC would have 2020 Terminal Tax to pay of $12,600.

If a payment is missed, the IRD will charge a late payment penalty, and will start charging Use of Money Interest, which is something we will cover in a separate topic! 


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