Provisional tax cash flow planning for New Zealand businesses

Provisional tax is one of the most common reasons profitable New Zealand businesses run short of cash. The business does well, the accountant files a strong return, and a few months later instalments arrive that are bigger than anyone planned for. For growing, seasonal and contract-based businesses, the timing can be brutal. This guide explains how provisional tax works, how each Inland Revenue option affects your cash flow, and how to plan so the instalments never come as a surprise.

The good news is that provisional tax is predictable once you understand it. You know the dates in advance, you can choose the option that fits your business, and you can set money aside as you go.

What is provisional tax and who has to pay it?

Provisional tax is income tax paid in instalments during the year, rather than in one lump after your return is filed. According to Inland Revenue, you'll have to pay it if you had to pay more than $5,000 of tax at the end of the year from your last return.

That end-of-year figure is called your residual income tax, or RIT. Put simply, it's the income tax left to pay after tax already deducted at source and any tax credits are taken off. If your RIT was over $5,000, provisional tax applies for the following year.

Provisional tax applies to sole traders, partners, companies and trusts that meet the threshold. For a company, it's the company's own tax. For a sole trader or partner, it's personal tax on business income, which is why so many self-employed people are caught out: their income isn't taxed through PAYE, so nothing is set aside automatically.

When is provisional tax due?

For most businesses with a 31 March balance date using the standard or estimation option, there are three instalments a year. Inland Revenue's published dates are:

Instalment	Due date (31 March balance date)	Falls in
First	28 August	The tax year you're paying for
Second	15 January	The tax year you're paying for
Third	7 May	Just after that tax year ends

If you're registered for GST and file six-monthly returns, you'll pay two instalments instead of three under the standard option. The accounting income method (AIM) and the ratio option follow their own schedules, which are linked to your GST filing and can mean smaller, more frequent payments.

Then, after your return is filed, any difference between what you paid and your actual RIT becomes terminal tax, due the following year. Your accountant will confirm the exact terminal tax date for your situation, particularly if they have an extension of time for filing.

Which provisional tax option suits your cash flow?

There are four options, and choosing the right one is the single biggest cash flow decision you'll make on provisional tax. This table compares them.

Option	How payments are worked out	Best suited to	Cash flow effect
Standard	Last year's RIT plus 5%, or RIT from two years ago plus 10%	Steady or rising income	Predictable, but can overshoot after a strong year
Estimation	Your own estimate of this year's RIT, revisable up to the final instalment date	A year you expect to be lower	Pays less if the year is weaker, but interest applies if the estimate is too low
Ratio	A percentage of your GST taxable supplies, set by Inland Revenue from last year	GST-registered businesses filing monthly or two-monthly with RIT of $5,000 to $150,000	Payments rise and fall with turnover
Accounting income method (AIM)	Calculated from profit through AIM-capable accounting software	Individuals and companies with turnover under $5 million	You only pay when the business makes a profit

A few eligibility points to note. The ratio option requires you to have been in business and registered for GST for the whole of the previous tax year and part of the year before, and it isn't available to partnerships. AIM needs accounting software that supports it. The standard option is the default for most businesses, but it's often worth asking whether one of the others fits better.

Why does provisional tax cause cash flow crunches?

Mostly because the payments are based on last year while your cash flow is based on this year. When the two don't line up, pressure builds. The most common triggers are:

• A strong year followed by a normal one. Under the standard option, instalments are based on last year's RIT plus 5%. If last year was a record, this year's instalments can be larger than this year's profits justify.
• Rapid growth. A growing business can face end-of-year tax on a much larger profit at around the same time as larger instalments for the new year. Two years of higher tax arrive in a short window.
• Lumpy or seasonal income. Fixed instalment dates don't care whether 28 August falls in your quiet season.
• Profit tied up in work in progress. Builders, manufacturers and exporters can show a healthy profit on paper while the cash is sitting in retentions, stock or unpaid invoices.
• No money set aside. Without PAYE doing the work, self-employed owners have to set tax aside deliberately, and it's easy to put off.

If one or more of these sound familiar, planning is worth far more than any fix after the fact.

How to plan provisional tax cash flow: step by step

Here's a practical routine that keeps provisional tax under control year-round.

1. Mark the dates. Put every instalment date for the year in your calendar and your accounting software, with a reminder two weeks ahead.
2. Review your option each year. Ask your accountant whether standard, estimation, ratio or AIM suits this year's forecast, not just last year's result.
3. Forecast profit quarterly. A simple forecast at each instalment date tells you whether the year is tracking above or below last year.
4. Set a percentage aside every month. Move a fixed share of profit into a separate tax account. Your accountant can suggest a percentage based on your structure.
5. Re-estimate if the year turns down. Under the estimation option, you can estimate at any instalment date or any other date up to the final instalment date. Be realistic, because a low estimate attracts interest.
6. Plan for the double hit in a growth year. If profits have jumped, budget for end-of-year tax on the big year and higher instalments on the new one.
7. Line up a backup early. If a crunch looks likely, talk to Inland Revenue and your funder before the due date, not after.

The tax account is your best friend. Moving a fixed percentage of profit across every month turns three painful lump sums into twelve small, predictable transfers.

How does use-of-money interest work on provisional tax?

Use-of-money interest is interest Inland Revenue charges on underpaid tax and pays on overpaid tax. On provisional tax, when it starts depends on your option and your RIT.

• Standard option, RIT under $60,000: interest runs from the day after the end-of-year tax due date, which gives smaller businesses a useful safe harbour.
• Standard option, RIT of $60,000 or more: interest runs from the day after the final instalment date, as long as your other instalments were paid in full and on time.
• Estimation option: interest is worked out on the difference between what you paid and your RIT, and can apply from the first instalment if your estimate was too low.
• Ratio option: if you apply the method correctly and pay the calculated amounts, you won't pay use-of-money interest when your payments fall short of the final liability.
• AIM: if you make your payments in full and on time, Inland Revenue won't charge use-of-money interest.

Inland Revenue doesn't charge or pay interest on differences of $100 or less, and interest you pay on underpaid tax is deductible for business purposes. Late payment penalties are separate. If an instalment is paid late, a 1% penalty applies the day after the due date and a further 4% on day 7, although the ongoing monthly penalty doesn't apply to income tax, including provisional tax.

Example scenario

A Canterbury residential builder had a record year, with residual income tax well above the previous year. Under the standard option, the new year's instalments stepped up sharply, and the end-of-year tax on the record year fell due in the same season. The problem was that much of the profit was tied up in retentions and a large payment claim due from a developer in four months.

The director owned a rental property in Christchurch worth around $780,000 with a small bank mortgage of $210,000. A short-term first mortgage of $190,000 refinanced the existing lender and covered the tax, with interest capitalised so there were no scheduled monthly repayments. The exit was the developer's payment and the retention release. The builder also moved to setting aside a fixed percentage every month the following year. This is an illustrative example only.

What if you can't pay a provisional tax instalment?

Act before the due date. You have more options beforehand than after. Consider these in order:

1. Check your option. If the year is genuinely weaker, re-estimating may lower what's due, but only if the estimate is realistic.
2. Pay what you can. Part-payment reduces the balance that penalties and interest apply to.
3. Talk to Inland Revenue. An instalment arrangement in myIR can spread the amount. Our guide to an IRD instalment arrangement vs a business loan compares the two.
4. Bridge the gap with a short-term loan. If the cash is coming, but not in time, a property-secured short-term business loan can pay the instalment and be repaid when the money arrives.

If tax has already fallen behind, our guide on how to pay off IRD debt with a business loan explains how to clear it. For businesses whose instalments collide with their quiet months, our guide to seasonal business cash flow has more ideas.

Key takeaways

• Provisional tax applies if your last return showed more than $5,000 of end-of-year tax.
• With a 31 March balance date, standard and estimation instalments are due 28 August, 15 January and 7 May.
• There are four options (standard, estimation, ratio and AIM), and the right one can transform your cash flow.
• Use-of-money interest depends on your option and RIT; under the standard option, RIT under $60,000 gets a safe harbour.
• Set a fixed percentage of profit aside every month and review your option every year.
• If a crunch comes, act before the due date: re-estimate, arrange or bridge the gap with a property-secured loan.

Need help bridging a provisional tax gap?

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Explore our working capital finance, or see if you qualify in a couple of minutes. There's no charge to enquire and no impact on your credit score. You can also call us on 09 875 4577.