Safe harbour for all provisional taxpayers using standard uplift method
(Clauses 80, 109 and 114)
Summary of proposed amendment
The amendments modify the calculation of use-of-money interest (UOMI) for taxpayers who use the standard uplift method to calculate their provisional tax.
The effect of the proposed changes will be to remove UOMI for the first two provisional tax instalments for these taxpayers, allowing them to pay their entire provisional tax liability for the year by the third instalment, with no UOMI charge.
The amendments will apply from the beginning of the 2017–18 income year.
New section 120KBB of the Tax Administration Act 1994 provides a new method of calculating UOMI for taxpayers who use the standard uplift method of calculating their provisional tax. When a taxpayer makes the instalments required by the standard uplift method for the first two provisional tax payments, no UOMI will apply to those instalments. Instead, UOMI will apply from the date of the third instalment. Given the third provisional tax instalment is almost one month after a taxpayer’s balance date, it will be possible for a taxpayer to square up their tax liability for the year at the third instalment date and have no UOMI charge.
When a taxpayer does not make the required instalments under the standard uplift method for the first two instalments, UOMI will apply on the lowest amount of the difference between the:
- the standard instalment amount due and the actual payment; or
- one-third of a taxpayer’s residual income tax for the year and the actual payment.
There are also two base protection measures included in section 120KBB. To be able to use the new calculation rule in section 120KBB, all associated persons must use the standard uplift method (or the GST ratio method) to calculate provisional tax and there must be no provisional tax interest avoidance arrangement. (A provisional tax interest avoidance arrangement is where one or more amounts of residual income tax have been manipulated with the purpose or effect of defeating the intent and application of the UOMI rules.)
A further base maintenance measure is proposed to section RC 5 of the Income Tax Act 2007, to prevent taxpayers from switching to the estimate method after a taxpayer has paid the first two instalments based on the standard uplift method.
The standard uplift method of calculating provisional tax is the easiest method for taxpayers to calculate and pay. It assumes a standard “uplift” based on the taxpayer’s prior year’s residual income tax (or the year before the prior year if a taxpayer has not filed their prior year return). The standard uplift method is the most commonly used method to calculate provisional tax and is used by 92 percent of provisional taxpayers.
However, using the standard uplift method can leave taxpayers in a position of having to pay UOMI when their current year income exceeds the 5% growth rate from the prior year (10% for the year before the prior year). This can seem unfair to taxpayers who have used the best information available to them to calculate provisional tax.
The amendments seek to reduce the impact of UOMI to taxpayers who have committed to, and paid, provisional tax based on the standard uplift method calculation.
When UOMI is removed from provisional tax payments the ability to manipulate incomes between associated persons can increase. At the extreme this could lead to taxpayers not being exposed to UOMI and no provisional tax payments being made by using different provisional tax methods. The amendments contain some base maintenance mechanisms to reduce the ability to enter into such arrangements.
Clause 109 introduces a new section 120KBB to the Tax Administration Act 1994. Subsection (1) defines which taxpayers may use the new standard uplift calculation method as those who:
- are not new provisional taxpayers;
- do not fall within the safe harbour rule in section 120KE (that is, the taxpayer’s residual income tax is over the proposed new $60,000 threshold or they have not made the instalments required to use the safe harbour); and
- use the standard uplift method to calculate provisional tax instalments.
All standard method associates must also use either the GST ratio method or the standard method and there must be no provisional tax interest avoidance arrangement in relation to the taxpayer.
Subsection 120KBB(4) defines a standard uplift method associate as “a person who is associated with the taxpayer” (person A), using the general association tests in section YB 3 of the Income Tax Act 2007, with some modifications.
Under the proposed new rules, a standard uplift method associate is:
- a company which is in the same wholly owned group of companies as person A (if person A is a company); or
- another person that is associated with person A treating section YB 3 as requiring 50% voting interest rather than 25% (if person A is a company or not).
Charger Limited is owned equally and run by its two shareholders Macintyre and Alistair Craig. Both draw shareholder-employee salaries from the company from which no PAYE is deducted. Charger chooses to use the standard uplift method to calculate provisional tax.
Macintyre and Alistair will be required to use the same provisional tax calculation method as Charger for that income year.
Subsection 120KBB(4) also defines a “provisional tax interest avoidance arrangement” as an arrangement that involves the manipulation of one or more amounts of residual income tax, including a zero amount of residual income tax, with the purpose or effect of defeating the intent and application of the interest rules in Part 7 of the Tax Administration Act 1994.
This is an overriding anti-avoidance section, which has the aim of ensuring that any remaining opportunities to manipulate income to avoid UOMI or the payment of provisional tax can be nullified. The consequence of not being able to use the proposed new calculation method in section 120KBB is to leave the taxpayer exposed to UOMI as they currently are from the first instalment of provisional tax.
Taxpayers who meet the criteria to use section 120KBB will apply the proposed modified UOMI calculation rules in subsection 120KBB(2) and (3). Which subsection applies will depend on whether the taxpayer has made the first two instalments required under the standard uplift method in full or not.
For taxpayers who make the first two required instalments on the instalment dates, subsection 120 KBB(2) will apply. This subsection moves the due date for the person’s residual tax less the two instalment payments made to the date of the third instalment for the purposes of calculating UOMI. This means the person will only be exposed to a UOMI charge from the third instalment date.
Thunderbolt Limited, a manufacturer of clapping devices for sports fans, has residual income tax of $250,000 in the 2017 year. Thunderbolt has trouble estimating its provisional tax due to volatility in its income. Sales volumes are highly dependent on the success of local sports teams – the more successful the teams, the more clapping devices are sold. Therefore Thunderbolt decides to use the standard uplift method to calculate its provisional tax payments, reducing the risk of UOMI applying if its estimate is incorrect.
For the 2018 year Thunderbolt makes two provisional tax payments of $87,500 per payment. At the third instalment date Thunderbolt has calculated that its actual annual liability is $300,000, due to the success of the local football team, the Fords.
Because Thunderbolt has made the two required instalments under the standard uplift method on time, section 120KBB(2) will apply and Thunderbolt’s residual income tax for the year, $300,000 less the two instalments made ($175,000), is due and payable on the date of the third instalment. This means that if Thunderbolt pays $125,000 as a third instalment it will have satisfied all its residual income tax and Thunderbolt will incur no UOMI.
Thunderbolt could just pay the required third instalment amount of $87,500, but will incur UOMI on the shortfall of $37,500 from the third instalment date until the outstanding tax and interest is paid.
For taxpayers who do not make the required instalments in full or on time, the timing rule in section 120KBB(3) will apply. These instalments are referred to as “failed instalments”.
If a taxpayer has a failed instalment, interest will apply to that instalment. The amount on which interest will apply is the lowest amount of:
- one-third of their residual income tax less the amount paid in relation to the failed instalment; or
- the amount they are liable to pay as an instalment amount under the standard uplift method less the amount paid in relation to the failed instalment.
This provision means that a person who does not pay the standard uplift amount in full or on time will incur UOMI on the lowest amount of the difference between one-third of their residual income tax and the payment in relation to that instalment, or the amount due as the instalment and the amount paid.
Challenger Limited uses the standard method for calculating provisional tax for its June year-end. Its residual income tax for the 2017 year is $20,500,000. This means its standard uplift method instalments will be 105 percent of that amount, being $21,525,000, and each instalment required to be $7,175,000.
Instead of making those first two instalments, Challenger makes a first instalment of $5,700,000 on 28 November 2017 and a second instalment of $6,800,000 on 28 March 2018. At the end of the income year Challenger calculates its residual income tax as $24,000,000, and makes a final instalment of $11,500,000 and an amount of $91,242 in UOMI. The total instalments made equal Challengers residual income tax payable.
Because Challenger has not made the required instalments under the standard uplift method they will fall within section 120KBB(3). Challenger will be charged interest on the lesser of one-third of its residual income tax for the year, less the instalment payment made or the instalment amount less the instalment payment made.
As one-third of Challenger’s residual income tax of $8,000,000 is greater than the standard method instalment of $7,175,000 the “lesser” amount in section 120KBB(3) will be the standard instalment amount.
Using this as the basis of the UOMI calculation, Challenger will be subject to UOMI on:
- $1,475,000 of the first instalment ($7,175,000 less payment of $5,700,000) from the due date for the first instalment to the date the amount was paid (the date of the third instalment). This UOMI amount is $80,876;
- $375,000 of the second instalment ($7,175,000 less payment of $6,800,000) from the due date of the second instalment until the date the amount was paid (the date of the third instalment). This UOMI amount is $10,366.
Challenger will not incur any UOMI from the date of the third instalment as all its residual income tax and the associated UOMI charge has been paid on that date.
For taxpayers who use the standard uplift method and make the first two instalments in full and on time, no UOMI will apply. This also means that if a taxpayer is overpaid no UOMI will be payable by the Commissioner until the third instalment.
Currently, taxpayers who use the standard uplift method can switch to the estimate method at any time before the third instalment of provisional tax. By removing UOMI from the standard uplift method, taxpayers who are overpaid prior to the third instalment could switch to the estimation method and have credit UOMI paid to them earlier. This would be contrary to the intention of the amendments, which is to reduce the impact of UOMI on taxpayers.
Consequently, an amendment to section RC 5(1) (clause 80) is proposed, to prevent a person who uses the standard uplift method and pays provisional tax equal to the amounts specified in section RC 10 for the first two instalments, from choosing the estimate method for the year.
This will only allow taxpayers who start using the standard uplift method to switch to the estimate method if they have not paid the second instalment under the standard uplift method.
Viper Limited has calculated their provisional tax liability for the 2017–18 income year using the standard method which requires instalments of $350,000 at each instalment date. Viper has made the first instalment but due to an unexpected downturn in sales realises that its total tax liability for the year will only be $100,000. Before payment of its second instalment Viper decides to switch to the estimate method so it doesn’t have to tie up working capital in tax payments. Also, it will be able to earn credit UOMI on its overpaid tax.
If Viper had made the second instalment based on the standard uplift amount it would not be permitted to switch to the estimate method.