Understanding Your Taxes (And How To Avoid Falling Into Tax Debt)
During Covid, the Inland Revenue took an amenable and forgiving approach to taxpayers who had fallen into tax debt.
This is no longer the case.
During Covid it was almost as if they were waving the white flag and saying “don’t do silly things, but if you DO, we won’t take a look…..(until it becomes politically expedient for us to do so i.e. NOW 🤨).
It’s one of the bigger reasons New Zealand company insolvencies actually went down during Covid. Even though sales fell off a cliff and companies were surviving off wage subsidies.
So, it’s very important to understand your tax obligations. Not even to steer clear of the IRD, but to give yourself and your business peace of mind.
Brief overview of the two common types of income tax payments
Most people struggle to understand the two most common types of income tax payments. Terminal tax and provisional tax. Terminal tax is your year-end tax bill. Once the accountant has done your books, there will generally be an amount of tax to pay (or refund).
Provisional tax is what’s paid during the year, generally across three instalments. It’s intended to align your tax payments with earnings, hence why you pay during the tax year, rather than at the end.
Tying the two together; if you’ve paid too much provisional tax, you’ll get a terminal tax refund at the end of the year, and if you’ve not paid enough because performance was better than expected, you’ll have some terminal tax to pay.
So why don’t you understand your tax obligations?
Many reasons. It’s difficult to provision for your provisional tax. Cash comes in, cash goes out. Provisional tax instalments come as a surprise during the year and you’re left without the cash on hand to pay.
So, firstly, get clear on your provisional tax obligations. Your accountant would have sent you tax returns to sign. Your obligations will be on the actual tax return. Sometimes you won’t need to pay provisional tax, but if you do need to, a schedule of payment dates and how much to pay on each date should be on the return. Also, your accountant will normally send you payment reminders before the due dates, so you pay on time – usually a few weeks beforehand. Jump ahead though and set calendar reminders for a month or two before these due dates so you’re better prepared.
Secondly, understand your cash flow. Prepare a cash flow forecast for the next twelve months. If you’re not sure how to, check out my article here where I explain how to and give you a free spreadsheet template (it’s really easy).
Next, get better at provisioning funds for your tax payments. Set up new company bank accounts separate from your main trading account. One for GST and one for income tax.
On a regular basis (weekly or monthly) set aside the GST from your sales into the GST bank account.
Then set aside 30% of your sales into your income tax account.
DO NOT TOUCH THE FUNDS IN THE GST OR INCOME TAX ACCOUNT. If you need to access these funds to operate your business, something else is going awry. You should be profitable on a pre-GST and income tax basis.
You can also open a fourth account for a cash flow buffer, which you CAN use to dip into during leaner times. Aim to build and then keep the balance of this account at 6 months of overhead costs. If overheads are $10k/month, aim to keep the balance of this account around $60k. You’ll avoid re-mortgaging the house with this strategy (thank me later 😜).
Are there other options if I don’t have enough cash?
Yes. There are always options, and that’s the cool thing about New Zealand. We tend to try and work together, rather than against each other.
If the business has taken a turn south, you can often get away with paying less provisional tax throughout the year. This needs to be assessed carefully though, or you may be hit with big penalties and interest costs if you get it wrong.
The IRD are also open to putting instalment plans in place whereby you pay off your taxes at an as-agreed fixed amount every month. They generally don’t like to drag these plans out further than 36 months though.
There are also tax financing houses that can be useful in certain situations. They usually carry a lower interest cost than IRD and are more flexible too.
Lastly, if you are just sick of the uncertainty around your taxes, you can shift your earnings to a PAYE salary
Instead of taking drawings out of the company, you can set up things so that your company pays you a regular PAYE wage, one with the tax already paid. Yeah, that company that YOU own and YOU control, can pay YOU a salary. Just like how your mates with jobs are paid 😊
This takes the stress out of having to worry about tax bills.
The downside is that it may not be as tax-efficient. However, sometimes you just can’t put a price on peace of mind.