Is tax pooling still relevant for managing your tax payments?
Tax Alert - April 2021
By Liz Nelson
Now that the 2020 income tax returns have been filed, it is time to look back and ensure that the right tax payments have been made to Inland Revenue.
At the same time, given the 2021 income year is coming to a close for many balance dates, final instalments of provisional tax will fall due over the next few months.
In this article we look at how tax pooling can not only help with getting provisional tax right, particularly in the context of the unpredictable times we are living in, but also provide flexibility in managing your cashflow around provisional tax.
Increased profits or missed payments
There will always be cases where mistakes are made or your precise tax liability cannot be calculated by the final instalment.
Taxpayers have the ability, provided the time restrictions are met (within 75 days of terminal tax date), to purchase tax from a tax pool in order to pay for missed instalments or to top up the final instalment of provisional tax. The process can be done online. For example if you have a terminal tax date of 7 April 2021, you have until 21 June 2021 to get your 2020 tax payments in order through tax pooling.
Based on our experience, it is generally possible to find sufficient surplus overpaid tax from taxpayers to match with taxpayers who have underpaid their tax for a given income year.
Ability to earn interest
One of the benefits of paying provisional tax to a tax pool is the potential to earn interest on overpaid tax.
Since 8 May 2020, Inland Revenue have been charging interest on underpaid tax at 7%, but only “paying” interest on overpaid tax at a rate of 0% (yes, that is not a typo), a spread that would make most people’s eyes water.
So, if you pay provisional tax directly to Inland Revenue and you overpay, you will receive no interest from Inland Revenue.
On the other hand, if you make tax payments into a tax pool, there is usually the potential to sell overpaid tax to other taxpayers and receive a return on the overpaid tax. We spoke to Tax Traders, who said they typically have sufficient demand to sell historic overpaid tax to taxpayers who have underpaid their tax, and the rate at which interest is earned can at times be significantly greater than an on-call interest bearing account. Tax Traders have indicated that large 2020 tax surpluses currently being sold are fetching quite attractive interest rates as there is significant demand for backdated tax for the 2020 income year.
Given the uncertain times, many taxpayers may be expecting a decline in profits, or loss carry-backs. What does that mean for provisional tax payments?
If you make provisional tax payments to Inland Revenue, you have two choices: pay based on the standard uplift method (which risks overpaying at the first two instalments if profits are declining); or take a risk and pay based on an estimate. The second option will expose you to that 7% interest rate if your estimate ends up being wrong.
Tax pooling provides a third option, allowing you to make payments directly into a tax pool based on your forecast without filing an estimate with Inland Revenue. Provided an estimate is not filed, interest will only be charged based on the lesser of your actual tax liability, paid in equal instalments, or your tax liability as calculated under the standard uplift method.
Depositing with a tax pool gives the protection of standard uplift in the event there is an upswing in profits later in the year, provided you are able to top up any underpaid tax from the tax pool.
Accessing refunds earlier
Getting a refund of provisional tax paid to Inland Revenue is no simple task – the typical request is subject to long processing times, may only be processed after the tax return for the relevant year is filed, and you may be asked to prove you have sufficient imputation credits.
Refunds of tax payments made to a tax pool are not subject to these restrictions, and can be paid out to the taxpayer at any time during the year. While there are Anti-Money Laundering (AML) requirements for accessing refunds, these can be dealt with online from a smartphone or tablet that has a front-facing camera, and can even be done when setting up a tax pooling account in order to ease the refund process.
Flexibility to finance
Outside of trading tax payments, tax pooling also offers taxpayers the option to finance future or past tax obligations. Tax pools can provide regular, structured payment options for taxpayers that can be built into forecasting and cash flow models, reducing the risk of late or missed provisional tax payments.
Most tax pools offer tax financing, allowing taxpayers to postpone tax payments at a competitive interest rate.
Taxpayers with irregular or unpredictable cash flows can choose to pay in flexible instalments or lump sums/pay as you go arrangements rather than fixed instalment amounts at set dates.
Further, the deposited funds can be drawn from as a line of credit, as an additional source of cash if required (with an option to be able to reinstate the deposit at a later date for a small fee in some instances). This option has been crucial for many taxpayers to bolster cashflow over COVID-19 lockdowns when access to other funding sources has been restrained.
These options can provide taxpayers with flexibility to manage tax payments in a way that better aligns with their cash flow requirements.
Audit / Voluntary Disclosures
Tax pooling assists in cases of increased assessments, either as a result of an Inland Revenue audit or through the voluntary disclosure process.
Provided specific requirements are met, taxpayers can purchase funds from tax pooling intermediaries in order to settle tax liabilities arising from increased assessments. The advantage of this is lower interest rates and potentially the elimination of late payment penalties. Tax Traders, for example, have backdated tax as far back as the 2009 calendar year if required.
Dog Walkers Ltd is a provisional taxpayer with a March balance date that pays provisional tax in three instalments. Dog Walkers’ RIT for the year ended 31 March 2019 was $150,000.
Dog Walkers has paid provisional tax for the 2021 year into a tax pool based on its 2019 RIT, being 110% of $150,000 ($55,000 at each instalment).
Dog Walkers has prepared its income tax return for the year ended 31 March 2020 and has RIT of $100,000.
Once Dog Walkers files its 31 March 2020 income tax return, its provisional tax obligations for the 2021 tax year under the standard uplift method will change to 105% of $100,000, dating back to the first instalment that was due on 28 August 2020 ($35,000 due at each instalment).
As Dog Walkers has paid $55,000 at the first two instalments, but is now only required to have paid $35,000 at these instalments under the standard uplift method, there is an excess of $20,000 at each instalment date that may be sold or swapped within the tax pool, giving it the opportunity to earn interest at a rate higher than the 0% paid by Inland Revenue.
Depending how the rest of the 31 March 2021 year goes, Dog Walkers may still be required to top up to the final tax liability on the final provisional tax instalment date for the 2021 year (due 7 May 2021). As Dog Walkers has a terminal tax date of 7 April 2022, Dog Walkers has until 21 June 2022 to arrange the relevant swaps to get their 2021 tax payments in order through tax pooling.
Tax pooling continues to be relevant under the recent changes to the provisional tax rules. We see the most benefit for taxpayers that pay all their provisional tax instalments directly into a tax pool.
For specific advice on the provisional tax rules or tax pooling, including how you can use tax pooling to settle your terminal tax, please contact your Deloitte tax advisor.
April Tax Alert contents
- Changes to the property tax landscape
- Latest tax legislation solves some problems you didn’t know you had
- Feasibility issues no more?
- OMG my tax return is wrong
- Is tax pooling still relevant for managing your tax payments?
- Recapping Deloitte’s FBT and employment taxes webinar – key things you need to know under the 39% rate
- Snapshot of recent developments