Article

New use of money interest rules for provisional taxpayers

Tax Alert - March 2017

By Veronica Harley

On 21 February 2017, the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Act 2017 received royal assent.  This Act contains important business tax changes that will have widespread application to many taxpayers from the 2018 income year.

The most significant change is that there will be a reduction, or in some cases elimination of use of money interest (UOMI) charges for many taxpayers that have committed to and paid provisional tax based on the standard uplift method.

Taxpayers using the standard uplift method

Currently UOMI on provisional tax applies with effect from the first instalment date.  When a return is filed, the actual residual income tax (RIT) is treated as if it were due and payable in even amounts on each provisional tax instalment due date and compared to the provisional tax instalments made.  From the 2018 income year, UOMI will only apply from the date of the third instalment for taxpayers who either:

  • use the standard uplift method (i.e. the 105% or 110% uplift rule) of calculating provisional tax for all instalments; or
  • use the standard uplift method for all instalments due before the final one [1] and choose to use the estimation method for the final instalment.

As the final instalment generally falls almost one month after balance date, the theory is that taxpayers should be able to more accurately determine at this point what their actual RIT will be, and square up any tax liability on the third instalment, thus incurring little or no UOMI at all. To the extent a taxpayer cannot accurately determine their tax liability by the final instalment due date, UOMI will only be charged from the final instalment date until it is paid in full, which should still shave quite a bit off the current UOMI bill.

Officials were concerned that the removal of UOMI could create opportunities for related parties to switch between the uplift and estimation methods to avoid UOMI and potentially also provisional tax by manipulating income between them.  Therefore, the rules require all “provisional tax associates” of the provisional taxpayer, where they are also liable to pay provisional tax, to either use the standard uplift method for all instalments; or use the standard uplift method correctly for the first two instalments before switching to the estimation method for the final instalment, or use the GST ratio method.  The definition of a provisional tax associate will capture other companies within the same wholly owned group or relationships between a company and a person (other than a company) where that person has a voting or market value interest of 50% or more in the related company.

Example 1:

  • ACME Ltd is a provisional taxpayer with a March balance date that pays provisional tax in three instalments. ACME is owned by Rudy (75%) and Chuck (25%).
  • ACME’s RIT for the year ended 2017 was $250,000.
  • ACME chooses to pay 2018 provisional tax instalments using the standard uplift method based on 105% of 2017 RIT and makes three instalments of $87,500 on each due date totalling $262,500.  Provisional tax instalments are due on 28 August 2017, 15 January 2018, 7 May 2018).
  • The 2018 tax return shows actual RIT of $270,000.

As Rudy owns 50% or more of ACME, he will be treated as a provisional tax associate of ACME.  Therefore if he is a provisional taxpayer, he will also be required to pay provisional tax on a standard uplift basis (as least for all instalments up until the final one) or he could use the GST ratio method.

As ACME has used the standard uplift method and made the correctly calculated instalments on time, ACME’s 2018 RIT of $270,000 is treated as being due and payable on the third instalment (rather than divided by three instalments as it is currently).  In this case UOMI would only apply from 7 May 2018 on the difference between actual 2018 RIT of $270,000 and the total instalment amounts paid of $262,500, i.e. of $7,500.

However, if ACME could accurately calculate what the 2018 RIT would be by the time the third instalment is due on 7 May 2018, it could instead make a final instalment of $95,000 so that there is no unpaid tax and therefore no UOMI.

 

Taxpayers can still choose to estimate their RIT if the actual RIT will be lower than what is payable under the standard uplift method.  UOMI will apply from the first instalment per current rules if they choose to use the estimation method for an instalment which is not the final instalment (i.e. the first or second instalment, assuming three instalments are payable).

However, taxpayers that switch to the estimation method for the last instalment will only incur UOMI (or receive) from their final instalment date provided payments have been correctly paid in accordance with the standard uplift method up until the final instalment.  The following example illustrates this:

Example 2:

Same facts as above except:

  • ACME initially chooses to pay 2018 provisional tax instalments using the standard uplift method based on 105% of 2017 RIT and makes the first two instalments of $87,500 on each due date totalling $175,000.
  • The 2018 draft tax return shows actual RIT will only be $150,000.
  • ACME decides to switch to the estimation method for the final instalment and estimates RIT at $150,000

ACME has used the standard uplift method for the first and second instalments and paid the correct instalments on time before switching to the estimation method for the final instalment.   In this case unpaid tax is deemed to be the actual RIT of $150,000 less the total amount of the relevant instalments for the year (i.e. 2 x $87,500 = $175,000). However, in this case a negative amount is treated as overpaid tax with no payment due and payable on that date. UOMI would only be receivable on the overpaid tax from the final instalment date of 7 May 2018 until a refund is received.

Note however, that if ACME had estimated its RIT on the second instalment date, UOMI rules would apply from the first provisional tax instalment (as they do currently).

 

It should be noted that if a taxpayer doesn’t pay or makes an incorrectly calculated instalment (not being the final one) on or before its due date, then UOMI will apply.  The unpaid tax on which UOMI is calculated is deemed to be the lowest of:

  • the amount a taxpayer was liable to pay for that standard uplift instalment less the amount paid in relation to that instalment; or
  • 1 divided by the number of instalment dates for the tax year multiplied by their actual RIT for the year less the amount paid in relation to that instalment.

UOMI will then apply on that unpaid amount from the relevant instalment date until the date the tax is paid.

Example 3:

  • Same facts as example 1 above except, ACME missed paying the second instalment on time and paid this late on 28 March 2018.

Although ACME has used the standard uplift method, it has not correctly paid an instalment on time.  The amount of unpaid tax that ACME has in relation to the second instalment is the lowest of:

  • the amount a taxpayer was liable to pay for that standard uplift instalment (i.e. $87,500) less the amount paid in relation to that instalment (i.e. nil); or
  • 1 divided by the number of instalment dates for the tax year multiplied by their actual RIT for the year (i.e. 1/3 x $270,000 = $90,000) less the amount paid in relation to that instalment (i.e. nil).

The lesser of these two amounts is the standard uplift liability that was due of $87,500 so UOMI will be calculated on this from the second instalment date of 15 January 2018 until it was paid on 28 March 2018.  It should also be noted that a late payment penalty would likely apply for missing the second payment and that no grace period operates when the late payment is a provisional tax payment.

 

There are a few other points to note about these rules:    

  • To qualify to use these rules, there must be no “provisional tax interest avoidance arrangement”; in other words the provisional taxpayer must not be part of any arrangement to manipulate their RIT so as to benefit from this rule.  Officials have now released guidance and provided a few examples that would be covered by this rule. For example, where shareholder-employees of a company and the company switch back and forth from one year to the next between leaving profits in the company to paying out all profits via shareholder salaries and estimating to nil where there is no commercial purpose for doing so other than to fall within the concessionary UOMI rules so that no UOMI is payable.

    The rule has been pretty broadly drafted however and the onus will be on taxpayers to be able to demonstrate there is a commercial reason for taking a certain tax position where there is a change in long standing approach, structure or use of provisional tax methods to prove it was not to work around these rules.
  • Tax pooling can continue to still be used by taxpayers who would rather estimate earlier, may not have paid enough to clear their liability in full at the last instalment or for taxpayers who end up being subject to UOMI because they fail to pay or miscalculate an instalment.
  • It has been common to make voluntary instalments of tax over and above the standard uplift payment to minimise UOMI that would apply from the first and second instalments.  Under these new rules taxpayers who correctly comply will not need to consider making voluntary instalments until the third instalment date.  No UOMI will be receivable by taxpayers who make voluntary instalments above the standard uplift amount prior to the last instalment.

Safe-harbour rule amendment

The safe harbour criteria which prevents the application of the UOMI rules applying at all for provisional taxpayers, has been amended with effect from the 2018 income year.  As well at the threshold increasing, the rule has also been extended to cover non-individuals. A taxpayer (whether a company or otherwise) will not be subject to UOMI on provisional tax if the following criteria are met:

  • RIT for the tax year is less than $60,000; and
  • The taxpayer has paid all three instalments using the standard uplift method (i.e. either the 105% or 110% uplift rule) correctly on or before the instalment date, or they have no obligation to pay provisional tax because RIT in the preceding year was less than $2,500; and
  • There is no provisional tax interest avoidance arrangement (in other words the taxpayer has not manipulated its RIT to fall within this rule).

This change will also mean UOMI will not be receivable for any overpayments, but the benefits of not being subject to the UOMI rules at all will be good news for smaller companies that find management of provisional tax difficult to get right.  It is of note that if a taxpayer does not pay the required instalment amounts correctly (e.g. payment is late or calculates a payment incorrectly) then the safe harbour rule will not apply.

This change is great news as there are a number of smaller companies currently with RIT around this threshold.  It means RIT will be deemed due and payable on their terminal tax date and so UOMI will only apply post terminal tax date to the extent any tax was not paid on the due date.

Final comments

These new measures apply from the beginning of the 2018 income year which for most taxpayers commences on 1 April 2017.  All provisional taxpayers should now be turning their mind to how these rules will apply to them.  Taxpayers with a standard balance date of 31 March will need to think about these rules in time for their first provisional tax payment due on 28 August 2017.  However early balance date taxpayers will have to think about this a little sooner.  For specific advice on how these rules apply to your situation, please contact your Deloitte tax advisor.

[1] Typically this would be the first and second instalments for taxpayers that pay in three instalments

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