Accounting Myths Busted - You don't pay tax in your first year of trading

As accountants our job is to work with our clients to help them ensure they are compliant with tax law and answer questions they may have along the way. At EBS we enjoy talking to our clients and we are here to help so we get lots of questions and often they are the same.

We jokingly refer to these as ‘Accounting Myths’ having been passed through people and are often based in fact but have been slightly become misunderstood along the way.

This article is going to clarify accounting myth ‘no tax in your first year of trading’ which is very common and not entirely incorrect, but I like to be very clear as if misunderstood will cause a major cash flow crunch in year two of your business if you are just starting out.

Income Tax is calculated in New Zealand mostly, using what is called the Standard option, this is where the previous years figures are used to add a small increase which is the amount of tax you pay in advance for the current year. If you have underpaid or over your tax when your tax return is filed at the end of the year you will have tax to pay or a refund if an overpayment.

So, you can see how there would be no tax owing in your first year of trading, as there is nothing from the previous year to base the estimate on.

The biggest problem we see with this comes in year two, after we have filed your tax return for that first year, if you have made a profit then you will have tax to pay for year one in the same period you will have tax to pay in advance for year two.

This unfortunately can be quite a struggle on cash flow being a startup business.

What can you do to avoid this struggle.

• Understand that there will be tax from your first year of trading, it may just be due later.
• Have a separate bank account which is your tax account and put 20% - 30% of all income into this account to cover tax when it is due with the IRD.
• Engage with an accountant to help with tax estimates throughout your first year and you can either save the money for tax in a separate account until it is due or pay it to Inland Revenue voluntarily based on estimated amounts.
• Register for Income Tax using the AIM (Accounting Income Method) which would mean you are paying tax based on profit as you file GST.

Hopefully this clarifies this comment just a little more so next time someone says to you that you don’t pay tax in your first year, you will know this isn’t entirely correct.