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Business Tax

How could provisional tax be improved?

Provisional tax is the mechanism by which most businesses pay tax during the year.  The exact amount of tax to pay for an income year can only be determined after the year has ended.  The provisional tax rules, however, are designed to ensure that tax is paid during the year, rather than at the end. 

For example, the calculation and payment of business income tax could be based more on when income is earned during the year – much like a PAYE for business.  This has the potential to simplify the calculation of provisional tax, create more certainty for businesses, and better reflect cashflow.  Alternatively, a simplified system where provisional tax payments are based on another proxy (for example, a percentage tailored on a business’s turnover) could also be investigated.

How important is improving the provisional tax rules in reducing compliance costs for business?  Are there other more important issues the Government should be focusing on instead, or as well?

The Government seeks feedback on ideas for more effective, practical and simple methods of calculating and paying provisional tax. How could provisional tax be better aligned to other business processes?

Comments

Paul Wilson
The GST Ratio method has many advantages over the standard provisional tax payment method. However the threshold of $150,000 RIT is too low, it needs to be increase.

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1 year ago
graeme
If we have earned the income then we need to pay our tax. The problem is how to deal with flucuating income and this crazy terminal tax in April and get and provisional tax in May. Make a genuine mistake and you are likely screwed. So maybe terminal tax at a different time and a fairer way to account for shortfalls. Ability to make adjustments through the year, voluntary payment or reductions. No late penalities calculated in the tax year the error way made,

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1 year ago
Noel Reid
Absolutely agree Paul. While we're increasing our portion of ARR, estimation is like gambling for us, because of the variable and lumpy portions of our revenues. I think the ratio method is fantastic. Perhaps is could be improved with a mid-year review of profitability, as we tend to overshoot or underpay by reasonably significant amounts. Now and then our profit level takes us out the top of the scheme, which is really disappointing.

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1 year ago
Sean Fitzgerald
As another commenter elsewhere said, how is this different to the ratio method ? And how would this apply to shareholder-employees ? What about use-of-money interest ?

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1 year ago
Mark Berghan
I do not think that companies should be paying provisional tax at all; especially smaller companies whose cashflow tends to be much more lumpy and newer companies who are often dependent on a smaller number of clients. With most modern accounting packages I can see no reason why you could not close off at the end of every 2nd month, have your reconciliations done and be ready to submit an electronic GST and Company Income Tax return by the 20th of the following month. Just makes sense to me.

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1 year ago
Simon Darby
I agree with Mark Berghan. Furthermore Provisional Tax on small business acts like a penalty in advance, often at a time when the business cannot afford it. It's hard to see how Provisional Tax is anything but a road block for small business growth. In the real world, cash flow is often hand to mouth, especially in those first 5-10 years. I suspect Provisional Tax forces many small businesses to offload any profits in advance (as wages, salaries, and other outgoings). This defeats the purposes of encouraging small businesses to save their capital for more important things such as growth which can operate at a different pace to annual taxes, for example, salting away capital for planned growth two or three years out. Instead, small businesses are effectively encouraged to spend all they can in order to minimise tax. The logic of penalty-like taxes such as Provisional Tax escapes me when other government initiatives promote growth. Perhaps it's time to rethink this.

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1 year ago
Priscilla Wilson-McGregor
I agree with Mark & Simon. Provisional Tax after one good year can be a severe penalty on a small business. In our business it comes at the worst time of the year for cash flow. Provisional Tax + Reduced Cash flow = Business discouragement and potential closure. We look forward to an improved system that encourages small business growth.

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1 year ago
Ian Anderson
Mark is suggesting modern accounting systems should allow companies to pay company income tax every 2 months along with their GST. Is that really what you are agreeing with Simon? Because reading the rest of your comment it sound like you think businesses should pay no tax at all!

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1 year ago
Cathy Oertel
I agree, Mark! Very good idea!

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1 year ago
Ian Clark
This makes so much sense. Surely it is a no brainer. Any year end adjustment could be done with the annual tax return.

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1 year ago
Marc Rocard
I agree with many of the comments. Cash flow at the start of the year is tough to predict and manage. The big payment of provisional and terminal tax is a killer. Tax is payable on retained income after expenses so the tax take percentage ends up wildly different for each company. However, a PAYE/GST style tax each two months at a rate of, say, 10% would be easy to manage for most. There would need to be a final wash up after the end of the financial year but having already paid some, 10%, most should manage that reasonably comfortably.

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1 year ago
Bob Henderson
I agree also. A system of tying "provisional Tax" and GST returns together would be beneficial in matching income and tax liability rather than guessing how much income a small business might make over a 12 month period in the future. The variables are just too many to make the current provisional tax system fair and equitable.

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1 year ago
Hanna Krause
I'm not a big fan of provisional tax either, but the tax system still has to work for people without modern accounting packages too or you might put up a different sort of barrier for a small start-up business. Maybe it would be an idea if you could choose between provisional tax and pay as you go?

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1 year ago
Denise Rodgers
I agree completely

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1 year ago
Graeme McMillan
I agree with Priscilla. I'm 2 years into my own one-man business. In Year 1, I had contracts carried over from my previous employer. Year 2 my income was substantially less than Year 1, so I could either pay provisional tax in full and get a refund several months later, or voluntarily underpay Provisional Tax knowing that if I suddenly received more revenue in that financial year, IRD would likely view my underpayment as late payment and penalise me for it. But with Year 2 income at one-third of Year 1, what else could I do? My income fluctuates hugely month on month, and I can go from having no work to landing a $10,000 contract in literally a couple of days.

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1 year ago
Noel Reid
Mark, you've brought forward the current GST paymt due date, from 28th to 20th following!! Cashflow considerations mean, for most of us, having to pay by 20th following would mean having to pay before a portion of our customers had paid us. I don't believe in recognising profit until "the money is in the bank". We shouldn't have to increase our business' Working Capital to cover paying taxes too.

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1 year ago
Graeme M
Mark Berghan's idea (save for the specific payment dates) has a lot of merit. If you have to have Provisional Tax, then pay as you go based on a 5 year rolling average automatically exempting any business under 5 years old. And reducing punitive measures is a must. The carrot and stick approach to eliciting payment is the essence of "class distinction" in our society. SME's have access to only very small sticks and "Do unto others..." usually serves them better anyway. The carrot (what carrot?) and BIG STICK of the IRD is more befitting of a despotic regime. The resulting alienation does not help Inland Revenue employees and policy makers any more than it serves proprietors of SME's and their employees.

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1 year ago
ChrisH
Agree with Mark, but has to be simple - not such that you need to get your accountant to do. Still need an annual wash-up though.

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1 year ago
Joy
I totally agree Mark. Businesses should not be paying provisional tax. It just over-complicates the whole thing.

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1 year ago
jeremy
I think a percentage system for provisional tax would be fairer or IRD should just wait till people have earned it before they collect their taxes. once it's spent it's spent how about managing tax better so you didn't need to get an advance every year? Small business are usually on the bones of their bums and some have to borrow to pay provisional tax and barley keep food on the table. they don't have a lot if money to have sitting in IRD accounts and if they make a loss and claim it back it's not paid back with interest that they could have been earning on it. Shame on ya.

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1 year ago
Donna Russell
As a very small business owner, I would really appreciate a change to the provisional tax system. While I try to keep money aside, there are so many tax bills in a short space of time near the start of the year - gst, final tax and provisional tax -- right when there is not a lot of cash flow as most of my clients have just been on holiday. Trying to predict future income with any accuracy is impossible in my business. PAYE seems to make sense, or better still not have it at all.

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1 year ago
Euan
So would you rather pay tax on a monthly basis , like a person on a salary.? You would end up, at the end of the month, with perhaps only 2/3 of the money, in the bank, that you have under the current system.

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1 year ago
Glenys
Yes, but much easier for budgeting purposes, no surprises and no lump sums at difficult times. It would smooth everything out. It would suit me, as a retailer, on a turnover of $750,000 approx. It could be treated like another monthly "supplier" and for us would be quite manageable. Plus if you have a quiet month there's less to pay at the same time that your cashflow is down (especially in a seasonal business)..

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1 year ago
carl
Our Limited Liability Company (LTD) is expected to pay provisional tax on the end-of-year net profit before tax. We supply Fonterra. We have absolutely no idea what the end of year profit is...clearly neither does the dairy industry. Ratio method needs to be an option, even if it is voluntary. And provisional tax needs to be reassessed each quarter in Volatile industries with more flexibility available for unpredictable changes - a simple letter/memo system, with a flag to refer abusers to "higher examination". At the moment Provisional tax sucks every spare dollar out of the company for the first six months, crippling our operation; then if things go badly we get some of the money back...but its as taxable excess so much of it goes back to government, rather than to reduce company overdrafts or invested into the business.

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1 year ago
Pamela Lawson
I agree with Donna and Carl. Provisional tax should be abolished and a fairer way introduced, whether it be monthly, two monthly or quarterly. The 15th January payment is a killer to most except retail. Being in a service industry, having a huge wage/holiday bill in December, GST and prov tax in January, GST in Feb, GST and terminal tax in April, prov tax in May - 4 months of high outgoings but little income as our clients are busy having holidays, paying off their credit cards and getting kids to school before they pay us - that usually takes them until March. Also a good year can be followed by a not so good year and somehow the funds must still be found.

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1 year ago
Euan
Under the proposals , the IRD will be taxing you SOONER rather than LATER. They could be taking the tax out of your bank account EVERY MONTH. Will that help your cash-flow.? The current system allows you to keep the money in your pocket for some time, and to plan, provide, or use an intermediary.

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1 year ago
Billy
At the end of the day you still have to pay income tax to the government? What does it matter if the flexibility is there to opt into monthly payments for provisional tax rather than the current system. I own two small businesses and I have in the last 8 years (and god willing will always) hit programmed provisional tax payments. Like Carl and Pamela say sometimes it is a struggle even if you have robust fiscal planning in place; the reality is you have good quarters and bad quarters in business. Flexibility as an option for when things get financially tough and an easy low cost process to modify payments scheduling, would be welcomed. Just my whakaaro.

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1 year ago
Euan
I see a whole can of worms in these proposals. Currently, provisional tax is paid by the shareholders in a small company, not by the company. Each shareholder may have a different tax rate. How will IRD calculate taxable profit when things like capital in and out, and depreciation have to be taken into account.? What tax rate will they use.? Currently their is plenty of time to set money aside for provisional tax, or to use an intermediary. I think this is just an excuse for IRD to tax on a MONTHLY basis.

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1 year ago
Graeme McMillan
I agree with Euan on the point that I'd prefer to have my tax money in my account earning interest rather than pay it monthly. The issue for me is not so much provisional tax, as the 'inflexibility' of the current provisional tax system. From a financial viewpoint, I would rather save revenue for 4 months and pay provisional tax, than pay tax monthly. But I think the provisional tax could be calculated in a similar fashion to PAYE in that there is a reconcilliation or estimation of that 4 month's worth of income on which a tax payment needs to be made. This would mean if I have a cracker previous year and a slow current 4-month period then I could pay a smaller amount for tax, but then if the next period is a cracker I'm not penalised for underpaying at the previous one.

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1 year ago
Peter
Raise the threshold from $2500 to $10000, solves most of the problem The rest can be solved by using outfits like tmnz.co.nz / taxpooling.co.nz or other tax pooling outfit. Pay when you have the cash and earn some interest. Why did the government restrict the time periods?

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1 year ago
Rachel Quartermain
Penalties on late payment of provisional tax should be calculated and shown immediately - some taxpayers don't realise they have penalties until a year or even more, later, by which time significant penalties can have accumulated.

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1 year ago
Euan
Yes that's a very good point. IRD used to chase up unpaid provisional tax and issue notices. Now , as Rachel says, they just let the penalties accumulate until the tax return is filed, and significant penalties have accrued. Just another excuse to gather revenue I suspect.

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1 year ago
Euan
It's a shame that the people who give a "thumbs down" to posts do not have the generosity to contribute to the discussion. They might have something helpful to say. But then they might not.

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1 year ago
Kelvin
My own story with provisional tax needs to be addressed in the changes. I was an IR3 filer as I had a business as well as being a salary earner. I filed my IR3 return with zero provisional tax to pay as that was what I knew at the start of the year and was accurate based on what I knew. However I was made redundant in the December. I briefly setup my own business as a consultant which created a provisional tax liability. I did the right thing in notifying IRD and updating my provisional tax estimate, and paying this on time. However when I completed my IR3 return for that year I was charged interest because I had not correctly estimated my provisional tax by August that year. A series of conversations with IRD resulted, my basic argument being that penalising me because I didn't predict the future and know I would be made redundant in the December was inherently unfair. There was apparently no discretion to have the interest waived (it wasn't much but was the principle of the thing) except in exceptional circumstances (requiring tax payers to predict the future did not qualify as exceptional but IRD making a mistake did ;-). The only option that IRD could offer was that I should have used the standard method for calculating the provisional tax at the start of the year, however this would have resulted in me substantially overpaying my tax had I not been made redundant. The changes need to come up with a provisional tax system that taxes businesses closer to the time that the tax liability becomes known and is incurred and that is flexible enough to penalise genuinely misleading provisional tax estimates and not those who are trying to accurately pay their tax based on unforeseen changes that happen during the year

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1 year ago
Euan
I think IRD are correct in that you should have used the "Standard method." If you use this method, you can not be penalised for shortfall payment of provisional tax. If you had been paid redundancy, the employer should have deducted PAYE from the payment and that would not have affected your provisonal tax. Setting up a business does not immediately create a provisional tax liability. You only become a provisional tax payer if your terminal tax liability is more than , I think, $2,500. Then you can choose whether to go with the Standard system or estimate provisional tax. If you do estimate, you can re-estimate at any time up until the last provisional tax liability is due, giving you plenty of time to reassess the situation.

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1 year ago
Glenn
Kelvins experience is relevant to all non-natural persons. in such a situation the estimation regime does not provide an adequate solution, and includes a penalty regime for under-estimation - since no-one likes to be penalised it is used with care, either by the taxpayer or their agent. For sole traders modern software packages allow them to possibly know with confidence their actual taxable profit by 7 May, but that is only 5 weeks after balance date. For many they have only cash-based reports at that date (not everyone uses full accruals based accounting systems), so even a 7 May estimation is a guess, and may still result in UOMI charged (though hopefully not very much). Example: Xero GST Cashbook users. They can see their cash-based Net Surplus, but usually need their accountant to process accruals, depreciation, loan interest, etc.

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1 year ago
Kelvin
The issue wasn't with the PAYE on the redundancy, it was with the provisional tax on the consultancy work. This work created a provisional tax liability greater than $2500 which incurred the interest penalty. You are correct that you can re-estimate at any time (which is what I did when my circumstances changed) but basically any re-estimate after August doesn't count, and a lot can happen between August and March that is unforeseen. Using the standard method would have created a provisional tax calculation for me, which in a normal year, would have resulted in me paying a whole lot of money up front that would then be refunded. For the year just gone the standard calculation for me would have been $9000, when my provisional tax for the year was actually zero as I expected it to be in a normal year for me. A system that would require me to pay this amount of money up front just to avoid possible penalties if something unforeseen happens from what I expect to happen is surely flawed. The point is that the current system requires us either to use the standard method which is a pretty blunt instrument when many business and individuals circumstances can change dramatically year on year and may cause us to way over or under pay our provisional tax upfront, or to estimate based on what we know is likely to be happen and take our chances on what might happen between August and March that is unforeseen, using the estimate method. The changes need to create a system that enables provisional tax to be managed closer to what happens in our circumstances through the year.

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1 year ago
Euan
Hi Kelvin. I don't understand why you were charged interest when you say your provisional tax was " actually zero." Hopefully you have a good accountant who you can bounce your concerns off, and who can advise you. My concerns with the proposals are that: 1.You can't correctly calculate taxable income without taking into account accruals, capital items, depreciation, etc, and this is usually done once a year. Anything else can only be an estimate of taxable income. 2.While some people struggle with the current system, the proposals will allow IRD to tax perhaps on a monthly basis.I don't see how that can help cash-flow. The existing system does give some time to plan and provide. No system is going to be perfect. .

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1 year ago
Kelvin
There were two different years. Year 1 - standard method would have been $4000 based on previous year, estimated $0 based on what I knew (and would have been correct if I wasn't made redundant). Was made redundant and went consulting which created a provisional tax amount of about $8500 which attracted the interest. Year 2 - standard method would have been around $9000 based on previous year but estimated $0 based on what I knew. Provisional tax in year 2 was $0 as estimated. If I apply the standard method both years or the estimate method both years I am disadvantaged one way or the other in one of the years. The current system just doesn't allow for this type of situation in a fair way as it penalises the taxpayer if the unforeseen happens

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1 year ago
Euan
As previously mentioned, Kelvin could have changed his estimate, and he could have made payments on account as the year progressed. The proposals are suggesting that each business installs IRD approved software that calculates your tax liability for you and that you pay on a PAYE basis, which , I assume, means monthly. Information from that software will FLOW THROUGH to Inland Revenue who will calculate your tax for you on a regular basis. No mention is made as to accruals, capital items, depreciation, business structure or the fact that a business might have several owners who are taxed at different rates depending on what is (currently) allocated to them at the end of the year.

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1 year ago
Kelvin
Yes you can change your estimates, and that is what I did. The issue is that any change after August that means you have an extra $2500 or more to pay attracts interest penalties as previously stated. Possible changes that involve paying monthly or software integration are separate issue

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1 year ago
Paul
No-one should need to know anything about all this absolute NONSENSE system to be compliant in a fair tax system. Tax should be simple. Kelvin's example is a shameful atrocity.

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1 year ago
Rob
Totally agree. The IRD interest and penalties regime blindly penalises even the most honest tax payers. It's impossible to accurately predict a year's profits, and even an error of a few thousand dollars sees us get his with interest and penalties. And if we over-estimate and pay too much tax, the interest returned by the IRD is laughable. Profits do not always flow evenly. A monthly payment regime could see our company paying out large tax amounts in one month, and clawing them back in the following month... it's a ridiculous proposition, clearly cooked up by some who is not experienced in business.

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1 year ago
Catherine
We are grape growers. Our income is very lumpy, there is a sizable portion that varies according to the season, and a large proportion of it falls into a later tax year cash wise. Accrual accounting is the only way to work out our annual income. As at our year end we could have 50% of our annual income as receivables. I cannot see how using GST and PAYE returns would allow a fair monthly or two monthly tax calculation for us. The provisional tax system, based on the previous year earnings and clunky though it can be, is the only reasonable way for us to be taxed. If, as some people state, there was no provisional tax we would have far greater problems with tax defaulting. It seems to me that some people are arguing they shouldn't have to pay tax at all while they are starting up. Get real!

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1 year ago
Euan
Yes I think some people just don't want to pay tax at all. From the 31st March, you get a full 12 months to pay your terminal tax and 7 months to pay the first instalment of provisional tax. How can paying tax on a monthly basis be better than that.? A lot of people simply don't plan and provide. I can't see how having the IRD take the money from a business each month can be better than the current system.

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1 year ago
Wendy
What about giving us a choice.....to either pay as you go, or as the current system. That way the different businesses can taylor their tax payments to suit their business character.

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1 year ago
Perry
I have to agree with Euan on most of his comments, even though he gets the thumbs down more often than not. At present the last provisional tax date is after year end which means with a half decent accounting package you can get pretty close. Then all that is required is a balance up on depreciation etc. The only problem at present is for people that use the 5%+ option on last years provisional tax - if your earning go down cash flow can become a real problem. In that case estimate and ensure your last prov tax payment is close (or you pay penalties). Our cash flow is up and down greatly month by month, thus to pay income tax monthly would create real hardship.

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1 year ago
Mary
Looking at the last point above, it has been suggested to me that far from doing away with provisional tax (in favour of paying tax on income as it is earned), the real long term aim of this review is actually for the government via IRD, receive their provisional tax EARLIER and more often i.e. paid monthly for example. The suggestion is that the REQUIREMENT to pay tax might well be related to how much is earned in the determined payment period but those monthly earnings will simply provide a threshold for how much provisional tax will be required to be paid. Are they REALLY going to do away with receiving lump sums in advance as is the current system? No. Call me paranoid if you like but I hope this is not a "Claytons" consultation process.

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1 year ago
Glenn
I agree with Mark Berghan, but believe payments could be monthly if effectively automated (ie: minimal or nil additional compliance work required of the business). The Ratio method was a move in this direction, but contained some murky hooks. How about initiating a system without fishhooks? Keep it simple, and stop being paranoid about the possibility of a few people gaining a small advantage under some unlikely scenario? Two monthly payments come up against the Christmas holiday conundrum. Though payment based on recent actual performance rather than a historical mean average + 5% helps, a payment of GST + multiple months income tax in late December is a problem for many businesses. Shifting the payment date to 15 January didn't help (though granted that did include 4 months worth of income tax, not 2 as Marks suggestion would require).

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1 year ago
Michael Keeley
I have a new business, and income is extremely variable - I have no idea what the total tax payable will be for the year; some months are bumper months, and some have zero income. Therefore provisional tax simply does not work, I can't make any sort of sensible estimate. The ratio method is great - being able to pay the provisional tax according to the income received works very well. BUT the problem with this is you CANNOT become a ratio payer until you have at least one year of income where RIT > 2500. That is too late - I need to be able to use the ratio method from day 1 of a new business starting.

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1 year ago
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