Quick answer
Provisional tax is income tax paid in instalments during the year, required once your residual income tax was more than $5,000. There are four options. Standard uses last year's tax plus 5%. Estimation uses your own forecast. Ratio links payments to GST sales and needs monthly or two-monthly GST. AIM, for businesses under $5 million turnover, works off actual profit through accounting software.
Key points
- You're in provisional tax once last year's residual income tax (RIT) was over $5,000.
- Standard: last year's RIT plus 5% (or the year before plus 10%), usually in three equal instalments.
- Estimation: your own forecast, re-estimated as often as needed, with interest risk if you under-estimate.
- Ratio and AIM tie payments to actual trading, which suits uneven or seasonal businesses.
Provisional tax is how New Zealand collects income tax from people whose income isn’t fully taxed at source. Instead of one bill after the year ends, you pay as you go. The option you’re on decides how much you pay, when, and how much risk of interest you carry. Pick badly and you can spend the year either overpaying or nervously guessing.
When do you have to pay provisional tax?
Inland Revenue’s test is straightforward: if your residual income tax (RIT) at the end of the last year was more than $5,000, you pay provisional tax in the current year. RIT is your income tax bill after credits such as PAYE and withholding tax come off.
In your first year in business there’s normally no provisional tax under the standard, estimation or ratio options, because there’s no prior year to base it on. That creates the famous second-year squeeze, covered in the second-year tax bill.
How do the four options compare?
| Option | How the amount is set | Who can use it | Cash flow feel |
|---|---|---|---|
| Standard | Last year’s RIT plus 5%, or RIT from two years ago plus 10% | Anyone (the default) | Predictable, but ignores how this year is actually going |
| Estimation | Your own estimate, revised as often as you like | Anyone | Flexible, with interest and penalty risk if you guess low |
| Ratio | A percentage of each GST period’s sales | GST-registered businesses filing monthly or two-monthly, RIT over $5,000 and up to $150,000, not partnerships | Moves with sales, so it eases in quiet months |
| AIM | Calculated from actual profit in your accounting software | Individuals and companies with turnover under $5 million | Pay only when profitable; no use-of-money interest if paid in full and on time |
Standard option: the predictable default
Under the standard option you pay last year’s RIT plus 5%, split into three equal instalments for a 31 March balance date (or two if you file GST six-monthly). If last year’s return isn’t filed by the time an instalment is due, the calculation falls back to RIT from two years ago plus 10%.
Its strength is predictability. You know the figures in advance, and for many smaller taxpayers there’s useful protection from use-of-money interest, explained in use-of-money interest in plain words. Its weakness is that it looks backwards: a booming year means a big terminal tax bill later, and a bad year means paying too much now.
Estimation option: your forecast, your risk
The estimation option lets you replace the standard figure with your own estimate, and Inland Revenue lets you re-estimate at any instalment date or any time up to the final one. If you genuinely expect no tax, you can estimate nil.
It’s the natural choice when profit is falling, or when last year included a one-off gain. The trade-off is risk: if your final estimate is lower than the tax you end up owing, you can be charged interest, and possibly a penalty if the estimate was too low. Keep a close eye on profit through the year and re-estimate as it moves.
Ratio option: tax that follows your sales
The ratio option uses a percentage that Inland Revenue calculates from your RIT and GST taxable supplies in an earlier year. Each GST period you pay that percentage of your sales, alongside the GST return, which for a 31 March balance date means six instalments: 28 June, 28 August, 28 October, 15 January, 28 February and 7 May.
Seasonal businesses like it because quiet periods mean small payments. The eligibility rules are tight, though: registered for GST throughout the previous year and part of the year before, filing monthly or two-monthly, RIT over $5,000 and up to $150,000, not a partnership, and you must elect it before the income year starts. Applied correctly, Inland Revenue won’t charge use-of-money interest for a shortfall.
AIM: pay on actual profit
The accounting income method (AIM) is the most precise option. Your AIM-capable accounting software calculates tax on profit for each period and you pay alongside your GST cycle. Inland Revenue’s summary is the attraction: you only pay provisional tax when the business makes a profit, and if you pay in full and on time, no use-of-money interest is charged.
It’s open to individuals and companies with turnover under $5 million. You need good, up-to-date books, and AIM users are switched back to the standard method at the start of each tax year until they re-elect by filing their first statement of activity.
Which option suits your business?
Illustrative example. A Christchurch joinery company paid $36,000 of RIT last year. This year orders are down. On the standard option it would pay $37,800 in three instalments of $12,600, even if profit falls by a third. On estimation it could estimate, say, $25,000 and pay about $8,333 per instalment, re-estimating if trade recovers. On AIM it would pay on actual monthly profit, so a slow winter means small payments.
A rough guide:
- Steady or growing profit, simple books: standard.
- Profit clearly falling: estimation, revised as the year unfolds.
- Seasonal sales, steady margins: ratio, if you qualify.
- Good software and lumpy profit: AIM.
Run your own figures through the GST & provisional tax set-aside planner to compare the instalments, then confirm the choice with your accountant. When you know what the instalments will be, the next step is having the cash ready on the right days; provisional tax dates lists them.
If the instalments and the plan collide
Sometimes the instalments are right but the timing is wrong: an instalment lands during a stock build, a growth push or the summer close-down. A planned facility can keep tax on schedule while the cash catches up. We consider unsecured options for trading businesses and lending secured on property, and you can check what’s possible without a credit check.
Before the next instalment
Choosing an option is a once-a-year decision with a twelve-month cash flow impact, so give it ten minutes with your numbers. If the business will need working capital to carry tax and growth together, talk to us early rather than in the week of the due date. Asking won’t touch your credit file, your details aren’t sold on, and a real person on our New Zealand team reads what you send. Accurate answers make for a useful first call. Start your enquiry.
Frequently asked questions
What is residual income tax?
It's the income tax left to pay for a year after tax credits such as PAYE and withholding tax are taken off. If last year's RIT was more than $5,000, you're required to pay provisional tax this year.
Which provisional tax option is the default?
The standard option. Unless you choose another, Inland Revenue expects payments based on last year's residual income tax plus 5%, or the year before plus 10% if last year's return isn't filed yet.
Can I switch from standard to estimation during the year?
Yes. You can estimate at any instalment date, or any date up to the final instalment, and re-estimate as many times as needed. Just remember that interest can apply if your final estimate falls short of the tax you actually owe.
Who can use the ratio option?
Businesses that have been registered for GST for the whole previous tax year and part of the year before, file GST monthly or two-monthly, aren't a partnership, and had residual income tax over $5,000 and up to $150,000. You have to elect it before the income year begins.
Is AIM only for companies?
No. AIM is available to individuals and companies with turnover under $5 million, provided they use AIM-capable accounting software.