**Disclaimer: This blog is intended as a general guide and may not cover all specific situations or reflect the latest legislative changes. For personalised advice that considers your unique circumstances, please consult a qualified tax professional.
Many new business owners in New Zealand believe that they won’t face tax obligations in their first year or even first two years. While at surface level there is truth to this, it doesn’t mean you’re not paying tax for the income earned during these periods. It just means the cash outflow is delayed. Essentially, you’ll end up paying more tax later, often catching new businesses off guard.
Let’s follow an example to break down the reality:
Jack has left his PAYE wages job as a builder to start contracting as of 1 April (the first day of the tax year).
Jack comes to us at the financial year-end (31 March) and we calculate he has a profit of $32,000 for his first year of trading, given all the initial costs. This leaves him with a terminal tax liability of approximately $4,500, which won’t be due until 7 April of Year 3—over two years after he first started earning his own income.
Jack comes to us at the end of his second year of trading. He’s had a significantly better year, with word getting around about his quality work and reduced initial costs. This results in a profit of $90,000.
Jack’s terminal tax liability for Year 1 of $4,500 is due 7 April of Year 3, but now he also has a Year 2 terminal tax liability of approximately $20,000, which will also be due 7 April of Year 4.
At this stage, Jack still hasn’t paid any tax for the income he’s earned in Year 1 or Year 2. However, because Jack’s Year 2 tax liability exceeds $5,000, the IRD now requires him to pay provisional tax for Year 3.
Jack’s business continues to grow at 20% year-on-year, reaching a profit of $108,000.
His terminal tax liability for Year 1 of $4,500 is finally paid on 7 April of Year 3.
He starts paying provisional tax for Year 3, calculated based on $94,500 (Year 2 profit plus 5% estimated growth). His provisional tax payments total $21,000, split into three instalments of approximately $7,000 each (due 28 August, 15 January, and 7 May).
However, his actual Year 3 liability, based on his profit of $108,000, is approximately $27,000, leaving a $6,000 shortfall to be paid as terminal tax.
Jack’s business stabilises at 20% growth, reaching a profit of $130,000.
His terminal tax liability for Year 2 of $20,000 is due 7 April of Year 4.
He continues paying provisional tax for Year 4, based on an estimated profit of $113,400 (Year 3 profit plus 5% growth). His provisional tax payments total $28,000, split into three instalments of approximately $9,300 each.
| Year | Profit | Terminal Tax Paid | Provisional Tax Paid | Total Tax Paid |
|---|---|---|---|---|
| Year 1 | $32,000 | – | – | – |
| Year 2 | $90,000 | – | – | – |
| Year 3 | $108,000 | $4,500 | $21,000 | $25,500 |
| Year 4 | $130,000 | $20,000 | $28,000 | $48,000 |
-The delayed tax payments in the first two years can create a false sense of financial freedom, but businesses must be prepared for significant cash outflows once tax becomes due.
-The introduction of provisional tax after the second year means businesses must pre-pay tax, even if their income fluctuates.
From day one of operating, set aside a percentage of your income in a separate ‘tax’ bank account. Generally, 30% is very safe, but see our [Tax Calculator] for a better estimate.
Remember, it is your total taxable income, not just business income, that determines your tax rate. If you had a part-year earning wages, although tax would have been deducted at source, it could still push you into a higher tax bracket.
