Is AIM the right provisional tax method for you?
About the Authors:
VERONICA HARLEY
Associate Director at Deloitte
Veronica Harley is an Associate Director in the National Tax technical team of Deloitte Tax & Private, responsible for providing insights and analysis on the latest tax policy developments.
Is AIM the right provisional tax method for you?
An additional option for calculating provisional tax known as AIM (Accounting Income Method) will become available for small businesses that use approved accounting software to prepare their accounts with effect from 1 April 2018. If you are a medium or large business reading this, take note that Inland Revenue very much see this roll out to small business as a pilot, with the intention that a form of it will be offered to larger businesses down the track. They are already exploring ideas for how to do this.
From 1 April 2018, taxpayers will be able to elect to pay two-monthly installments of provisional tax which will be based on the current tax adjusted income to be calculated automatically by the software. The use-of-money interest regime will not apply to payments made under this method.
The reasoning behind introducing this method was the concern that small businesses were stressed about managing provisional tax because of the uncertainty or unpredictability of income and the existing assumption that income is earned evenly throughout the year was often incorrect and unfair.
The theory is that if businesses make more regular payments which are more closely aligned to income as they earn it, this will assist taxpayers who find it difficult to budget for tax payments. Hence, AIM was born and the software providers have been working behind the scenes with Inland Revenue to make this a reality. This is despite the poor adoption of the GST ratio method of calculating provisional tax which already exists for small businesses. The GST ratio method, introduced in 2006, was also designed for small businesses to make regular provisional tax payments which are based on a percentage of GST supplies so that tax payments align more to income as it is earned.
It would be fair to say some of the “gloss has worn off” since AIM was first promulgated in April 2016. This is mainly because that at the same time this method was introduced, the Government also made significant changes to how use-of-money interest applies on provisional tax with effect for the 2018 income year. These changes include raising and extending the safe harbour rule before use-of-money interest will apply and removing use-of-money interest from the first two payments of provisional tax where the standard up lift method is used. These two changes alone have been very beneficial for most taxpayers such that smaller businesses may now fall outside the rules completely or at least can better manage their obligations and cash flow as a result.
The second reason enthusiasm is waning is that now the finer details have been released of how this new method will work, it’s becoming clear that this method won’t necessarily suit all the small businesses it’s aimed at (excuse the pun). We have set out below the key questions to help you determine if this method is right for you. There are some attractive features of this method, but whether they are enough to tempt taxpayers into this method is a big question.
Who is eligible to use this method?
Taxpayers who have annual gross income of less than $5 million and who use an AIM capable system that has been approved, are able to elect to use this method. There is also the ability for taxpayers with gross income greater than this threshold to apply for the Commissioner’s approval to use this
method. That said, trustees and beneficiaries of trusts, partnerships, taxpayers with investments in foreign investment funds (FIFs) or controlled foreign companies (CFCs), Maori authorities, portfolio investment entities and superannuation funds are precluded from using this method.
Software providers must have their system approved by the Commissioner before they can offer this method within their software. This is so the Commissioner can check to see if the software can make the minimum necessary tax adjustments as required. Software companies that will have been approved will likely advertise this capability directly to their clients that use this software. From the taxpayer’s view point, the taxpayer will see the option to access this functionality within their software once it’s available. However taxpayers may need to seek professional advice from their accountant before electing this method. There is an important set up process to work through to ensure the method calculates the tax payments with the minimum of manual intervention, otherwise there is great potential for compliance costs to outweigh any benefits.
How does it work?
Most taxpayers will make six installments of provisional tax under this method; although those GST registered taxpayers who pay GST on a 1-monthly cycle will make 12 monthly installments. The installment date is dependent on whether they are GST registered and the cycle of their taxable period. Taxpayers must opt into this method at the beginning of the tax year before the first payment would be due. Taxpayers with a March balance date will be liable to make their first installment on 28 June 2018.
Provided the initial set up is completed correctly and the taxpayers maintain accurate real time
accounting records, then the AIM capable software should automatically calculate a provisional tax installment that is reflective of the tax payable, broadly based on tax adjusted income earned at that point in time.
Certain tax adjustments are mandatory under this method. The Commissioner has recently released a number of technical determinations which cover the various tax adjustments to be taken into account when an installment is calculated. Tax adjustments may be required for tax depreciation and depreciation recovery income, trading stock, livestock, private expenditure, debtors and creditors (if they are registered for GST on an accruals basis) and non-deductible provisions. There is also a determination covering the use of
tax losses.
On set up, taxpayers will be required to make various decisions on how AIM will calculate provisional tax and whether or not to make tax adjustments for certain items. Taxpayers should discuss this step with their tax advisors to ensure the method suits their business and that they are able to comply with the rules specified in the technical determinations that accompany this method.
In theory, if set up is completed correctly, these should just happen automatically within the software. The tax adjustments do not impact the underlying accounting system – they are merely
taken into account for the calculation of provisional tax. A pre-enrolment alert will be sent to the tax
agent to let them know of a taxpayer’s election into this method.
Before each due installment date, the AIM capable software will automatically calculate the payment due and map the relevant ledger accounts into a “statement of activity”, which is then submitted directly via the software to Inland Revenue. The statement of activity’s purpose is to demonstrate the robustness of the accounting system behind the amount paid as provisional tax. Taxpayers will be able to see it before it is sent to Inland Revenue.
It is similar to the Summary of financial statements (IR10) form with some additional AIM information added, e.g. refund instructions in the case of an overpayment. The summary isn't classified as an income tax return and isn't processed as one which means mistakes can be fixed in the next statement.
It appears that manual tax adjustments can also be made at this point if the system has not been set up to make tax adjustments automatically.
What are the advantages of this method and why would I opt for it?
Tax payments made throughout the year should broadly align to the actual tax liability meaning tax payments and cash flow can be better managed.
The use-of-money interest regime will not apply to provisional tax payments made under this method if the year-end residual income tax liability is different. However, note that use-of-money interest will still apply from terminal tax date. Use-of-money interest and late payment penalties would also still apply should the taxpayer pay less provisional tax than the amount the AIM capable system calculates.
If income drops to the point that provisional tax payments already made under the AIM method to date have been overpaid, a real benefit is that refunds can be refunded or transferred before the year end.
This method would particularly suit those businesses with lumpy or seasonal income because tax is paid at the same time the income is earned. However, if a taxpayer earns all income at the beginning of the year, this may not be seen by all as an advantage! Likewise start-up companies may be better served by the GST ratio method that already exists and doesn’t require payment for the use of accounting software if they are not already using it.
What are the pitfalls and things to look out for?
If the initial set up is not completed properly, there is the potential for significant additional compliance if manual adjustments need to be made for each installment. We think it is essential that taxpayers involve their accountant in first deciding whether the method is for them and, if so, helping to set the method up so it produces the right tax payments each time with as little manual intervention as possible. This may mean some initial compliance costs will be incurred by the taxpayer.
In some instances the requirements imposed by the tax adjustment determinations may be too prohibitive to be worth the trouble. For example, while tax losses can be brought forward, grouping of tax losses from other companies is not permitted. Therefore, company taxpayers in a group of companies with losses available to offset are unlikely to want to elect this method. Another consideration will be whether a tax depreciation schedule is maintained within the software or not, how frequently this is updated and whether manual adjustments will be required. Similarly for taxpayers with trading stock or livestock, there are particular issues to consider before electing into AIM. There are definitely a few other fishhooks to be aware of depending on a taxpayer’s circumstances and type of business. One size does certainly not fit all in this regard.
The success of this method will hinge on the extent to which the underlying accounting information is correctly coded at the outset so there is no need to make manual adjustments at each installment. For example, to minimise manual adjustments, private expenditure will need to be coded by the taxpayer correctly to the shareholder’s current account. The system should ideally be set up to automatically make private use adjustments for business assets such as vehicles when related expenditure is incurred. Otherwise there is a mandatory requirement for a manual adjustment to be made. Any errors or omissions made are expected to be fixed in the next period. Despite the fact that “close enough may be good enough”, the bottom line is that taxpayers must still take reasonable care when calculating tax liabilities under this method and could still be exposed to penalties for not doing so.
Not all tax adjustments that you will ultimately make in a tax return are mandatory when calculating the provisional tax installment (e.g. entertainment). This means there is potential for the actual residual tax liability to be different, unless these additional entries can be set up to occur automatically by the AIM capable software. It is expected that taxpayers can choose to make these additional adjustments manually or automatically if the particular software will allow this.
While it is believed that AIM will be able to get taxpayers to a position of having less terminal tax to pay, once the AIM installments are made the taxpayer still has to complete a tax return as usual.
Taxpayers who choose the AIM method are prevented from using tax pooling to manage provisional tax payments and cash flow, although tax pooling can still be used for terminal tax and reassessments of tax.
There is also the question of whether taxpayers would want to simply rely on the activity statement that is produced by the system or whether the statement of activity should be reviewed by a tax agent each time or at least initially, until there is confidence about what is being produced. Although, we think initially Inland Revenue is likely to be fairly hands off until the method is bedded down and it can review how the method is working in practice.
While Inland Revenue downplay this aspect, a taxpayer is in effect supplying Inland Revenue with a mini set of financial statements every two months and therefore far more information about their business and activity than is currently the situation. Some taxpayers may not be comfortable about this. We think it is possible that Inland Revenue could run data analytics on such data submitted down the track if it wished to.
Conclusion
Inland Revenue is currently actively marketing this method to taxpayers through the various channels it has. This is only likely to ramp up the closer we get to 1 April 2018 as the software providers are ready to go live with this product. The key message is to do your homework and talk with your advisor before electing in.
Associate Director, Tax
Deloitte
Phone: 09 303 0968
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