The easiest way to think about provisional tax is to imagine you’re prepaying income tax for the current year in advance.
Why do I need to prepay my tax?
If you’re a “normal” employee, your employer withholds your tax and sends it to the IRD every pay period. This is the Pay As You Earn (PAYE) tax. It’s easy for the employee – you may not like that it’s deducted, but at least you don’t need to do anything further.
If you receive (part of) your business profit, then no tax has been deducted throughout the year. You would prepare your tax return and pay the full amount of tax by April the next year. This has two drawbacks:
- The IRD doesn’t get paid for a year
- You need to come up with a lot of tax in April and it kind of sneaks up on you
To solve this, the IRD has come up with a sort of middle ground. You don’t need to pay tax every month unless you’re an employee, and you don’t need to come up with a lump sum in April (one payment). Instead, you prepay your tax in three instalments and then do a wash-up in April (four payments in total).
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