Understanding the Use of Money Interest System

18 Jul 2017

Some taxpayers are subject to use of money interest when they don’t pay their tax, pay late or underpay.

Note on proposals currently under consideration

New provisional tax rules have been proposed for the 2018 and later income years. They involve an accounting income method of payments of provisional tax which will allow taxpayers with an annual turnover of less than $5 million to pay income tax using tax software at the same time GST returns are filed. These are proposals at the time of writing and are subject to consultation and subsequent change.

For the time being, the system works as set out below.

When do you have to pay Use of Money Interest to Inland Revenue? *

There are three categories of taxpayers that pay use of money interest. These are:

• taxpayers who have estimated their provisional tax
• taxpayers who have earned income which has either not been taxed, or has not had enough tax deducted from it, and the end of year residual tax works out at $60,000 or more
• taxpayers who pay their taxes late.

* Note the above categories apply for taxpayers from the 2018 income year (from 1 April 2017 for 31 March balance dates).

How is the actual amount of Use of Money Interest calculated?

Use of money interest rates are set by the Inland Revenue Department. They are set at a level which is intended to discourage taxpayers from using the IRD like a bank. At the moment the rate at which you pay use of money interest is 8.22%. The rate at which you receive it (if you overpay your tax and you are in one of the above categories) is 1.02%.

If you are late paying your taxes, you will incur a use of money interest charge until the account is clear. Even if you enter into an arrangement to pay off your taxes over time, you still have to pay the interest (in these cases you will often be able to avoid any further penalties).

In all other cases, the calculation of the interest is a little complicated and, an example is probably the best way to demonstrate it:

Let’s assume a Company has an Income Tax Liability (Residual Income Tax) of $45,000. During that year it paid provisional tax of $30,000 on an estimation basis in three equal instalments on the due date. We will calculate the interest up until 31^st July (being 4 months after balance date).

Although the terminal tax (in the example this is the shortfall of $15,000) isn’t due to be paid until 7 April, the use of money interest continues to accrue until the tax is paid. So if the above tax was paid on 31 July, a total of $697 interest would be payable. Interest continues to run at the rate of $3.38 per day until the tax is paid.

The calculation formula does not take into account any seasonal variations that occur in your business income cycle. For example, if you make most of your money in the latter part of the year, it will make no difference to the calculations. IRD will assume that your income was earned evenly throughout the year.

Provisional taxpayers using the standard uplift method

For all taxpayers who use the standard method to calculate and pay provisional tax, use of money interest is not payable on the first two provisional tax instalments but will only apply from the third instalment. Note this applies from the 2018 income year (from 1 April 2017 for 31 March balance dates).

Using another example to demonstrate this:

Let’s assume a Company has an Income Tax Liability (Residual Income Tax) of $75,000. During that year it paid provisional tax of $57,750 on the standard uplift basis in three equal instalments on the due date based on their previous income years Residual Income Tax of $55,000 (an uplift of 105%). We will calculate the interest up until 31^st July (being 4 months after balance date).

 

As with the previous example, even though the terminal tax (in this example this is the shortfall of $17,250) isn’t due to be paid until 7 April, the use of money interest continues to accrue until the tax is paid. So if the above tax was paid on 31 July, a total of $322.44 interest would be payable. Compared to the previous example, no interest would accrue from the first and second instalment dates under the standard uplift method. Interest will however continue to run at the rate of $3.88 per day until the tax is paid.

For taxpayers who use the standard uplift method and have an Income Tax Liability (Residual Income Tax) of less than $60,000, use of money interest will not be payable on any resulting shortfalls at each instalment date. Note however, use of money interest will still be payable where the Income Tax Liability (Residual Income Tax) has not been paid by the terminal tax date (7^th April of the year following balance date for a 31 March balance date taxpayer).

Minimising Use of Money Interest

Where you are likely to fall into the interest regime, it may be advisable to make voluntary payments of provisional tax as you go, as it is likely that you will find it cheaper to finance your tax payments through your trading bank or by using a tax pooling intermediary.

We strongly recommend that you gain access to a good computer package that is capable of producing reliable and regular management reports, so that you are able to see your income unfolding as the year progresses. We have access to some excellent computer packages. You may wish to take responsibility for the completion of those reports yourself, or you may wish us to complete them for you, as so many of our clients do.

In any event, the importance of regular tax planning, in consultation with us, is self-evident.

The GST Ratio option

There is another option for paying provisional tax which avoids the charging of use of money interest. It only applies to provisional taxpayers that are also GST registered. This means that partners in a partnership are not able to use this option as they are not GST registered (it is the partnership that is GST registered and the individuals that are the provisional tax payers).

To be able to use the GST ratio option:

• you must have been GST registered for more than two years
• your residual tax liability must be under $150,000
• you must be on a one-monthly or two-monthly GST registration
• you have to apply to IRD before the end of the current income tax year.

When using this option, IRD will determine an appropriate percentage which you use to pay your provisional tax. Then, every two months you will include a payment of provisional tax in your GST return. The payment will be based on the amount of your income. There is the ability to make an adjustment for any asset sales that may also be included in your income for a certain period.

If you do choose to use the GST ratio option, you will no longer be charged use of money interest.

This may suit your business better than the current provisional tax regime – especially if you have fluctuating seasonal cash flow patterns. We can discuss this with you further if you are interested.

Our Recommendation

Make sure you have a broad idea of your likely tax commitments in advance. We can prepare a tax plan for you.

If your income circumstances change, let us know as there may be provisional tax consequences.

Please contact us on succeed@pkfcs.co.nz or call on 876 8124.