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 tailored to your unique circumstances, consult a qualified tax professional.
Many new business owners assume they won’t need to pay tax in their first year or even first two years. While there is some truth to this, it doesn’t mean you’re avoiding tax—it simply means the payment is delayed. This often catches business owners off guard, leading to unexpected cash flow issues.
How First-Year Tax Delays Work
Let’s break it down with an example:
Year 1: The Start of Jack’s Business
Jack has left his PAYE job as a builder to start contracting full-time from 1 April.
By the end of his first financial year (31 March), Jack’s profit is $32,000. His tax liability of $4,500 isn’t due until 7 April of Year 3—over two years after he started.
Year 2: Jack’s Business Grows
Jack has a strong second year, earning $90,000 in profit.
His Year 1 tax bill ($4,500) is due in Year 3, but now he also has a Year 2 tax liability of $20,000, payable in Year 4.
Because Jack’s tax now exceeds $5,000, the IRD requires him to start paying provisional tax in advance for Year 3.
Year 3: Provisional Tax Kicks In
Jack’s profit continues growing at 20%, reaching $108,000.
His Year 1 tax ($4,500) is finally paid.
Now, he must also pre-pay tax for Year 3, based on his Year 2 profit plus 5% growth, totaling $21,000 in three installments.
However, his actual Year 3 tax liability (based on his new profit of $108,000) is $27,000, meaning he still owes $6,000 extra.
Year 4: Full Tax Obligations in Effect
Jack’s business reaches $130,000 in profit.
His Year 2 tax bill ($20,000) is due, and he must also pay provisional tax for Year 4 based on a 5% estimated growth.
Comparing Tax Payments Over Time
| 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 |
Key Takeaways for Business Owners
- Tax deferral in the first two years doesn’t mean tax-free income—the bill will come later.
- Once tax liabilities exceed $5,000, businesses must start paying provisional tax.
- Cash flow planning is crucial—many business owners struggle when they suddenly owe multiple years of tax at once.
A Simple Solution to Avoid Tax Surprises
From day one, set aside at least 30% of your income in a separate tax account. Want a more precise estimate? Try our Tax Calculator.
Remember, your total taxable income (not just business earnings) determines your tax rate. If you had a part-year earning wages, it could push you into a higher tax bracket.