Paying a large lump sum of income tax at the end of the financial year can be challenging. Provisional tax helps to spread out tax payments throughout the year instead.
Provisional tax is a method of paying income tax in instalments during the year, based on an expected income. If the provisional tax paid exceeds the actual income tax liability, a tax refund is issued after the annual income tax assessment is completed.
As of 2015, the threshold for provisional tax is $5,000 of residual income tax (RIT). If RIT is below this threshold, provisional tax does not need to be paid.
To calculate provisional tax, an estimate of income for the upcoming year must be made. This process involves a degree of judgment and forecasting.
There are four available methods (as of 2025) for calculating provisional tax, depending on the nature of income and business operations:
1. Accounting Income Method (AIM)
- Requires the use of AIM-capable accounting software such as Xero or MYOB.
- The software submits a Statement of Activity to Inland Revenue, detailing income and expenses.
- Provisional tax payments are only required when the software determines a profit has been made.
- Suitable when income is expected to increase year over year.
- Payments are typically made in three instalments.
- The provisional tax amount is calculated as:
- Last year’s residual income tax plus 5% uplift, or
- If based on residual income tax from two years ago, 10% uplift.
- This method is simple and predictable for businesses with stable or growing income.
- Recommended when income is likely to decline.
- Income can be estimated and updated multiple times throughout the year.
- The estimate can even be set to nil, though penalties may apply if Inland Revenue considers the estimate unreasonably low.
- Designed for businesses with variable income throughout the year.
- Provisional tax is calculated based on GST returns, using a ratio calculated from GST returns and taxable supplies and therefore requires monthly or 2-monthly GST filing.
- Tax is paid in six instalments per year.