Guidance on tricky provisional tax issues released

By Veronica Harley

In mid-December 2018, Inland Revenue issued two draft Questions We’ve Been Asked on provisional tax and use of money interest implications (PUB00336). The introduction of the use of money interest concession rules as they apply to provisional tax with effect from the 2018 income year, while welcome, has given rise to some uncertainty in a couple of scenarios.

One of these is in relation to new provisional taxpayers who meet the definition of having an “initial provisional tax liability” because the interest concession rules do not apply in this case. Persons with an initial provisional tax liability are broadly those who start a new taxable activity and have residual income tax (RIT) of $60,000 or more in their first year. While new provisional taxpayers have no obligation to pay provisional tax because their RIT for the preceding tax year is $2,500 or less, they are nonetheless still exposed to use of money interest (UOMI) from their first instalment. The number of instalments a person has in their first year will depend on when the business commenced in that first year. This has caused advisors to look at these rules more closely in terms of whether a person has an initial provisional tax liability or not.

The first QWBA is Income Tax - Provisional tax and use of money interest implications for a person in their first year of business. This focusses on the meaning of taxable activity, and what level or type of activity is sufficient to mean a taxpayer is “deriving income from a taxable activity” for the purposes of the initial provisional tax liability definition. The conclusion is that the start of a taxable activity is a concept well understood in the GST context and it also applies to the provisional tax rules. It includes anything done in connection with the beginning of a taxable activity as well as any activity carried on continuously or regularly, irrespective of profit, involving or intended to involve the supply of goods and services. For the purposes of the provisional tax rules, a taxable activity includes GST-exempt supplies and applies to persons who are not GST registered. For example, the receipt of passive interest income on capital raised in the year prior to the commencement of the business in the following year, would be treated as being “something done in connection with the beginning of a taxable activity”. If the interest income was such that it resulted in RIT of more than $60,000, the taxpayer will have an initial provisional tax liability in that year.

The second QWBA, Provisional tax – impact on employees who receive one-off income without tax deducted, deals with the scenario that a salary and wage earner receives a one-off lump sum (e.g. from an employee share scheme) which has not had any tax deducted at source. Where it results in RIT that is over $2,500, it makes them liable to pay provisional tax for that year (section RC 3(1)).

The statement clarifies the interaction of subsections RC 1(1) and (3) of the Income Tax Act 2007. In the Commissioner’s view, the fact that the prior year’s RIT may be less than $2,500 does not “remove them from the provisional tax rules as they continue to retain their status as a provisional taxpayer under the Tax Administration Act 1994 by being “liable” to pay provisional tax under section RC 1(1) of the TAA, despite having no obligation to pay provisional tax under section RC 3(3) of the TAA”.

The statement also confirms that if a provisional taxpayer has no RIT assessed in a prior year, or their RIT was less than $2,500, their instalment payments using the standard method will be zero on each occasion. They can top up the instalment at P3 to ensure they pay the entire RIT for the current year on that final instalment date in order to minimise UOMI. Bear in mind that because they have had RIT that is over $2,500 in a tax year, a person will be required to pay provisional tax the following year. If they elect to use the standard method, this will result in payments being made in the subsequent year of at least 105% of the prior year’s RIT.

The problem is that an employee in receipt of a one-off amount of income without tax deducted will not be expecting to derive any further income of this nature in the subsequent year. As a result, they may choose to adopt the estimation method and estimate their provisional tax at nil and then make no payments at each instalment in that subsequent year. However, if they choose the estimation method, they are exposed to UOMI on any shortfall at each instalment date. This is because the UOMI concession rules do not apply if the estimation option is selected for instalments due prior to the final instalment. Consequently, if the employee adopts the estimation method for the succeeding year, they need to understand these risks when making that choice should it turn out that their RIT is more than $2,500.

The new UOMI concession rules were intended to simplify provisional tax for taxpayers but, in some respects, they did anything but as new boundaries have emerged as a result. The provisional tax rules can be very complicated in some scenarios and so it’s good to have this guidance. If taxpayers are ever in doubt about provisional tax, we suggest seeking advice because there are a few tricks within these rules which could prove costly if mismanaged.

Both statements have a feedback submission date of 8 February 2019. If you would like to discuss these, please contact your Deloitte tax advisor.

February 2019 Tax Alert contents

• Payday reporting is just around the corner
• Tax reform bill progresses
• Inland Revenue goes back-to-basics

• New rules for companies with Australian connections
• A Snapshot of Recent Developments