What is Provisional Tax?

What is provisional & terminal tax?

If you’re a provisional taxpayer your Accountant will tell you to pay provisional tax 2-3 times a year and terminal tax once a year. But what are these tax amounts for? And WHY are they costing you so much money! Let’s do a quick run down of what these pesky payments are and pull it together with an example!

Provisional Tax

This is tax that you’re paying in advance that goes towards your tax liability for the current tax year. It’s a bit like when you have a wage paying job, you have tax deducted before you get your pay (that’s why your payslip will have a bigger number as the ‘gross’ wages but what’s actually deposited into your account is much less). Your employer then pays the tax they’ve withheld across to IRD on your behalf so your tax should be all paid up by the end of the Financial Year. Provisional tax works much the same except you make the payments yourself, so at the end of the financial year, you’ve already paid some tax to IRD.

Terminal Tax

Terminal tax is the previous years tax ‘wash up’. This is done when we complete your Financial Statements and tax return/s. We’ll calculate what your profit is and how much tax should’ve been paid on this profit. We’ll then deduct the provisional tax you’ve paid throughout the year leaving us with the difference and VOILA this is your terminal tax.

Okay that was a lot of words – let’s put it into context with an example.

Example time!

Here’s the situation for both of the following examples. You’re a sole trader and have made a profit of $70,000 for the last financial year. Total tax payable on $70,000 of income is $14,020.

Example 1

You’ve paid $20,000 of provisional tax throughout the year

Tax Liability =                     $14,020
Provisional tax paid =      $20,000
Difference =                     -$ 5,980

You’ve paid more tax than you needed to so will get a refund of $5,980 – Sweet!

Example 2

You’ve paid $10,000 of provisional tax throughout the year

Tax Liability                           $14,020
Provisional Paid                - $10,000
Terminal Tax Due               $  4,020

The total tax payable on your $70,000 profit is $14,020however you’ve only paid $10,000 towards this so will need to pay IRD an additional $4,020

Want to calculate your estimated tax liability? Use our handy calculator on the home page!