Provisional Tax with Xero 'Sweet As'
Why the Accounting Income Method (AIM) for Provisional Tax is Great News.
It’s not often the Inland Revenue gives us something for nothing, but in a few weeks’ time it’s going to feel like Christmas has come early for a lot of small businesses.
The IRD’s generous gift goes by the rather dull name of the Accounting Income Method for Provisional Tax - or AIM for short - but it’s far more exciting than its title suggests. Here’s why…
AIM saves you time and money
AIM takes the guesswork and risk out of calculating your company’s income tax instalments (aka provisional tax) by making sure you always pay the right amount and never have to pay penalties or interest charges.
This means it’s going to be a much better option for most small businesses when it comes to deciding which provisional tax option to use.
Current problems with provisional tax
“Because most people don't know how much tax they'll need to pay next year, calculating provisional tax usually involves a certain amount of judgement.”
Before we get to explaining the nuts and bolts of AIM, let’s first take a moment to explain why provisional tax currently causes so many problems.
Most businesses have fluctuating financial results – not just from year-to-year but from month-to-month. However, none of the existing provisional tax options (standard, estimate or GST ratio) work at all well in such circumstances.
No matter how diligent you are in choosing the best option, you just can’t win at the moment - pay too little tax and you’ll definitely be hit with interest charges (and quite possibly penalties) but pay too much, and you’ll be putting an unnecessary strain on your cashflow.
If it turns out you’ve paid too much provisional tax, you have to wait until you’ve filed your year-end tax return before you’ll get a refund. That’s valuable cash that you could be using elsewhere.
Interest charges! Most people don’t realise that the current IRD interest rate is a whopping 8.22% if you’ve underpaid your tax. However, if you’ve overpaid, the IRD will use a miserly 1.02% in calculating your credit.
Penalties!! Now this is where things can get seriously hairy. If the IRD deems your provisional tax payments to be “unreasonably low” then you’re going to get hit with a minimum 20% penalty on the unpaid amount - plus, of course, actually paying the shortfall. But wait, there’s more – if the mistake is more serious, the penalties go through the roof; for example, “gross carelessness” attracts a 40% penalty.
Thankfully the Inland Revenue has now acknowledged that there are problems with the current system; hence the reason why they’ve introducing AIM.
The benefits of AIM
AIM is a winner because it addresses many of the weaknesses in the current system; namely:
AIM is great for cashflow because it uses your most current financial results to calculate your provisional tax payments. That means your payments during the year are going to be far more accurate and if, for example, you’ve been in profit but then make a loss, you’ll get an immediate refund of any overpaid tax.
AIM is the safest option because as long as you take “reasonable care” there is no exposure to penalties or interest. The caveat here is that to must pay what your software (i.e. Xero) tells you to, in full and on time.
Switching to AIM is easy; and once you have, the tax calculation and processing is all handled within Xero.
Because AIM can be used by any business with less than $5m annual turnover, most of the half-million odd small businesses in NZ can use it – even sole traders, contractors and the self-employed.
AIM is more forgiving - if you make a mistake in one period, just correct it in your next Statement of Activity and move on.
AIM is ideal for businesses who have fluctuating financial results. Hold on, isn’t that every business?!
AIM is definitely one change to our tax legislation that you want to take a closer look at. But don’t delay because if you want to use it in the new tax year, you need to decide soon; otherwise you’ll be stuck with your old method for another 12 months.
In the meantime, if you’ve got any questions, please don't hesitate to contact us direct.