How is Income Tax calculated?

October 11, 2022

One of our biggest jobs as accountants is advising on what tax to pay and when. It is very important that we get this as accurate as we can if you pay too little the Inland Revenue charges penalties and interest, pay too much and this money is left at Inland Revenue earning very little interest when it could have been used for other useful purchases in your business. Of course, there is also the timing of Income Tax dates, which vary based on the client’s balance date and frequency with which they pay GST (if they are GST registered), so lots for us to think about to ensure we are advising you correctly.

Income tax rates

Income tax is charged at different rates depending on your structure for business, the first two are

          Company                                    28%

          Trust                                         33%

If you are trading as a sole trader, partnership or a Look Through Company these rates all come back to the individual tax rates based on level of income

          Up to $14,000                             10.5%

          Over $14,000 and up to $48,000      17.5%

          Over $48,000 and up to $70,000      30%

          Over $70,000 and up to $180,000    33%

          Remaining income over $180,000    39%

What is considered income for income tax purposes?

If you are employed as an employee the wage or salary you earn is your income, your employer will deduct PAYE which is income tax just known by another name. This is the easiest way to be taxed as it is taken care of for you.

Being in business it gets a bit more complicated and the amount of profit you make each year (Income earned less allowable expenses) is the amount that is taxed.

Different calculation methods

When you are in business you pay two types of income tax;

          Provisional Tax         Income tax paid in advance

          Terminal Tax           End of year square up based on actual tax return figures filed

Traditionally and still the most common method used is called the Standard method, this is where Inland Revenue takes your previous years profit, adds a 5% increase, and bases your provisional tax on this figure. As you can imagine guessing like this for a seasonal business, new business with no previous figures or a high growth business you can see that this would have some accuracy issues. If you are using this method for paying tax it is highly recommended that you file your end of year accounts as early as possible, so accurate amounts are being used for your provisional tax calculations.

Other options include estimation, this is where you are able to provide an estimate to Inland Revenue on what you think your tax will be and pay based on this. Accountants try not to use this method as the penalties for under estimating are much higher than other methods.

An alternative method to the Standard and Estimate option is AIM or the Accounting Income Method, this is where tax is paid at the same time GST is paid, based on actual business results. This is a fantastic option for a growing or seasonal business as it means tax paid is relative to income earned.

When is tax due

Unfortunately there are a few factors that affect the dates you pay tax, so best to discuss this with your advisor, standard dates are below;

          Terminal Tax                     7th April the following financial year

If you are a standard March balance date and file GST monthly or two monthly;

          First Provisional Instalment            28th August

          Second Provisional Instalment        15th January

          Third Provisional Instalment           7th May

If you are a standard March balance date and file GST six monthly;

          First Provisional Instalment            28th August

          Second Provisional Instalment        7th May

This information is a brief overview and we always recommend talking to your advisor for specifics.

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