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February 6, 2017

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How To: Make Sense of Terminal & Provisional Tax

August 22, 2017

Death and taxes are often referred to as the only two things we can never escape. For many business owners, tax is a swear word to never be uttered and can send shivers down the spine of even the most hardened businessman. It doesn't have to be this way. Knowledge is power so read on as we break down Terminal Tax and Provisional Tax so you can face it with confidence and plan for the inevitable tax take.


If you are trading well and making a profit, you will eventually have to pay tax on this profit. If you have done really well, you will have to pay tax in advance based on what the IRD thinks you will make in profit next year. For the year ended you will be paying Terminal Tax, for the year coming you will be paying Provisional Tax.


Terminal Tax

Terminal Tax is the end of year clear up of tax due on your taxable profit.


In your first year that you make a taxable profit, your Terminal Tax will be the total tax due on all of your declarable profit. If you have been paying taxes throughout the year, like Provisional Tax, then your Terminal Tax will be the difference between the taxes you have paid to date and the total tax due on your taxable profit.

Lets look at an example:
Client Company Ltd has just completed its first year of trading and has made a taxable profit of $10,000. As they are a company they pay tax at a flat rate of 28%. The total tax due on their profit is $2,800. This is their Terminal Tax and as they have not paid any taxes during the year they have to pay this full amount to the IRD in one lump sum.


If your Terminal Tax is over the threshold set by the IRD (currently $2,500) then you will need to pay Provisional Tax.


Provisional Tax

Provisional Tax is the tax that the IRD would like you to pay in advance for the year in progress, based on your previous profit.


You are currently only required to pay Provisional Tax if your tax to pay on your previous years profit was $2,500 or more. When you are in this position, the default method of calculating Provisional Tax is to take the previous years figure and add on 5%.


Lets look at an example:

From the example earlier, Client Company Ltd had Terminal Tax of $2,800 for the year just finished. This means that they now need to pay Provisional Tax. The Provisional Tax they need to pay is going to be the total tax payable for the previous year plus 5%. This means that their total Provisional Tax due will be $2,940.


Don't panic, unlike Terminal Tax, Provisional Tax is not due in one lump sum. Instead, Provisional tax is split into payments throughout the year and if you calculate that it is an over payment when you file your next tax return, you will be refunded the difference and have no Terminal Tax to pay.


Key Dates

Lets continue with Client Company Ltd as our basis for this as your circumstances can alter the dates a bit, they are GST registered on two-monthly basis and have MBP as their accountants and tax agents. This means that their Terminal Tax will be due on the 7th of April in the year after balance date (e.g. Terminal Tax for the year ended 31st March 2017 is due 7th April 2018).


Their Provisional Tax is due in three installments in line with their GST cycle. They will have one installment due on the 28th of August, the next on the 15 of January and the final installment on the 7th of May.


In the second profitable year of business all of these taxes can be quite a burden but they really shouldn't be. Plan ahead and make sure that you have money in a tax savings account to cover the inevitable taxes. Talk to your accountant about what is a good portion of your revenue to squirrel away into savings so that you don't have painful cashflow issues come tax time.


In Summary

Terminal Tax is the end of year clear up for the year just finished. If you have made more than before you will have tax to pay. If you have made less and been paying Provisional Tax, you will likely have a refund due.


Provisional Tax is paying in advance for the taxable profit you are currently earning so that you don't have to pay it all in one big lump sum. 


Still in the dark? Get in touch with the team at MBP and they can help get you sorted.



This advice is general in nature. Every situation is unique and requires tailored advice. MBP have the expertise to help you make informed decisions about your business and taxes to preserve cashflow while you focus on the things you love doing, including growing your business. Get in touch for a free consultation by emailing mailbox@mercerbp.co.nz or call us on (07) 378 6655.


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