AIM, standard or estimation: which provisional tax option fits you?
If you've ever paid provisional tax, you used one of three methods to work out the amount. The catch is that most business owners never actually chose theirs. They were put on the standard method by default when they first crossed into the provisional tax net, and they've stayed there ever since, whether it suits the business or not.
That's fine if your profit is steady. If it isn't, the default can have you paying too much, or paying at the wrong time for your cashflow. So it's worth knowing what the three options are and which one fits the shape of your business.
A quick refresher
Provisional tax is how you pay your income tax through the year, in instalments, rather than in one lump after year end. Think of it as paying this year's tax before the year is finished, based on an estimate of what you will owe. If you want the full picture of how it works, our plain English guide to provisional tax covers it end to end.
For a standard 31 March balance date, the instalments usually fall on 28 August, 15 January and 7 May. The method you use decides how each instalment is calculated. There are three main options.
Option 1: the standard method
This is the default, and for good reason. It's simple and it gives you certainty.
Under the standard method, IRD takes last year's residual income tax, adds a set uplift of usually 5 percent, and splits the total across your instalments. You know the numbers in advance, and as long as you pay on time and in full, you're protected from use of money interest.
The trade-off is that it looks backwards. If this year's shaping up to be much bigger than last year, you can still face a terminal tax bill in April because you underpaid along the way. If this year's quieter, you're handing IRD more than you need to and waiting months to get it back.
The standard method suits you if your profit's fairly steady year to year and you value simplicity over fine-tuning.
Option 2: estimation
If you know this year's going to look quite different from last year, you can estimate your own provisional tax instead.
You tell IRD what you expect your income tax to be, and you pay that across the instalments. Done well, it lines your payments up with reality. You're not overpaying in a slow year, and you're not caught short in a strong one.
The catch is that the responsibility sits with you. Estimate too low and IRD can charge use of money interest on the shortfall. Estimation works best when you've got good, current numbers to base it on, and when you're willing to review your estimate as the year goes on rather than setting it once and forgetting it.
Estimation suits you if your income swings noticeably and you've got reliable, up to date figures to work from.
Option 3: AIM
AIM, the accounting income method, is the newest option, and it runs straight out of your accounting software.
Instead of basing your tax on last year or on a guess, AIM calculates it from your actual results as you go. Xero works out a provisional tax figure each time you file GST, based on the profit you have genuinely made in that period. Slow couple of months, you pay less. Strong run, you pay more. Our full guide to AIM goes deeper on how it works.
The big advantage is that you never pay tax on profit you haven't earned, and you're far less likely to meet a surprise at year end. The trade-offs are that your bookkeeping needs to be accurate and current, because AIM's only as good as the numbers going into it, and it generally suits businesses turning over under 5 million dollars.
AIM suits you if your income's seasonal or unpredictable, your Xero's kept tidy and up to date, and you'd rather your tax followed your real cashflow.
So which one fits?
There's no single best answer, only the best fit for your business.
If your profit's steady and you like certainty, the standard method's hard to beat. If your year's going to look very different from the last and you've got the numbers to back a forecast, estimation can save you from overpaying or underpaying. If your income moves around and your books are in good shape, AIM keeps your tax in step with how the business is actually tracking.
Whichever method you use, the habit that takes the fear out of provisional tax is the same: set money aside as you earn it, so the cash is there when the instalment lands.
The worst option is the one no one chose. Sitting on the standard method by default, in a business where income swings hard, is how owners end up either lending IRD money for free or opening a nasty terminal tax bill in April.
If you're not sure which method you're on, or whether it still fits, it's worth a proper look before the 28 August instalment. We're always happy to talk it through and help you choose the option that suits your business and your cashflow. Get in touch and we'll point you in the right direction.