“Simplifying” Provisional Tax: Accounting Income Method

Keitha McClure Accounting & Compliance, Managing Cash, Reducing Tax

So the IRD are trying (and more-or-less failing…) to simplify Provisional Tax. In a valiant effort, they’re bought in the “Accounting Income Method” (AIM).

In short, from 1 April 2018 you’re able to pay Provisional Tax based on your business’s profits. The idea is good – pay your tax when you earn the money. The detail isn’t so good – the devil is in the detail.

The problem historically is that you (generally) make three even Provisional Tax payments in August, January and May. This is fine if your income is consistent across the year, but a nightmare if you have a quiet patch (like the Christmas shutdown) and need to pay Provisional Tax.

To solve the problem, AIM matches your tax payments and business income during the year.

This sounds good right? Not always. AIM will work well for some (a few) taxpayers but not for others.

It works well for those who have a 100% tidy accounting system. If your Xero is in perfect shape, then it’s great. If it’s messy, or out of date, then your tax payments will be messy under AIM.

As an aside, in our experience most Xero accounts have problems in them. If you’d like to get yours in top shape then read this now.

You also can’t use AIM if you’re operating under a partnership or Trust structure, if your turnover is more than $5m, or if you have overseas investments.

Now for the complicated part (yes, the bit above is the easy bit). When deciding whether to use AIM, it’s important to remember the following under AIM:

  1. Tax losses are only available when the previous years tax return has been filed, and it ignores group offsets.
  2. Livestock Farmers need to value stock at each installment date.
  3. Trading Stock (what you buy and sell) needs to be included in your accounting software (this means either running a perpetual stock system, or by doing physical stock takes every 2 months).
  4. Depreciation and fixed assets can skew when your paying tax, especially where you’re not doing management accounts with your GST Returns.
  5. Accounts payable and receivable need to be included if you’re doing GST on an invoice basis..
  6. Private Expenditure (e.g. home office or vehicle expenditure) must be adjusted for at each installment date.
  7. Shareholders Salaries become a nightmare. Most companies pay all, or a significant portion of, the taxable profit to shareholder using a shareholder salary. When using AIM to work out the tax payable by the company, a deduction is allowed for the lesser of; a provision for shareholder salaries or the income of the shareholder employee based on the tax paid on their behalf. In our experience most companies do not make any provision for shareholder salaries payable until the end of the year when the final profit is known. AIM only covers the tax payable for the company, not necessarily the shareholder’s provisional tax.

Not all of these tax adjustments will apply to every taxpayer but, if the relevant tax adjustments aren’t included in the tax return at each installment date, the taxpayer may end up paying an incorrect provisional tax amount.

It should be noted that penalties can apply of AIM is used inappropriately.

So in our view, while AIM is well intentioned, it will be more or less meaningless in practice. If you think it’s for you, or if you’re interested in finding out more, feel free to get in touch.