When do you have to pay Use of Money Interest to IRD?
There are four categories of taxpayers that pay Use of Money Interest. These are: Companies or Trusts (non-individuals) that pay tax in their own name Individuals who have estimated their provisional tax
Individuals 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 $50,000 or more
Taxpayers who pay their taxes late
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 8.40%. The rate at which you receive it (if you overpay your tax and you are in one of the above categories) is 1.75%.
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 Tax) of $45,000. During that year it paid provisional tax of $30,000 in three equal instalments on the due date. We will calculate the interest up until 31st July (being 4 months after balance date).
Provisional Tax Instalment Date 1/3 of Residual Tax Actually Paid Shortfall No. of Days Charge to 31st July following Balance Date 28th August 15,000.00 10,000.00 5,000.00 337 387.78 15th January 15,000.00 10,000.00 5,000.00 197 226.68 7th May 15,000.00 10,000.00 5,000.00 85 97.81 Totals 45,000.00 30,000.00 15,000.00 712.27
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 $712.27 interest would be payable. Interest continues to run at the rate of $3.45 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.
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.
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
1. Be informed. Make sure you have a broad idea of the likely tax commitments in advance. We can prepare a tax plan for you.
2. If your income circumstances change, let us know. There will be provisional tax consequences.