Provisional tax: standard, estimation, ratio, or AIM?

Once your end-of-year tax bill passes $5,000, Inland Revenue stops waiting until year end: you pay the following year's tax as you go, in instalments. What most contractors don't realise is that how those instalments are calculated is a choice, with four methods on offer, and the right one depends on how predictable your income is. This guide compares them and covers the safe-harbour rule that decides how much the choice actually costs you.

The standard option: last year plus 5%

The default, and what most contractors should use. Your instalments total last year's residual income tax plus 5% (or the year before's plus 10%, when last year's return isn't filed yet), split equally across your instalment dates: three payments for most contractors, two bigger ones if you file GST six-monthly.

Its logic is "assume this year looks like last year, slightly bigger." When that's roughly true, it's unbeatable: predictable amounts, known dates, nothing to monitor. When income jumps, you underpay through the year and settle the difference at terminal tax; when income drops, you've lent Inland Revenue the difference until the refund.

The safe-harbour rule (read this before optimising)

Interest is what makes provisional tax decisions matter, and the safe harbour is what makes most of them not matter: if your residual income tax ends up under $60,000 and you paid your standard-option instalments in full and on time, Inland Revenue charges no use-of-money interest on any shortfall. You simply pay the difference at terminal tax.

For a large share of contractors, that closes the question: use the standard option, pay on time, and a good year costs you nothing extra until terminal tax day. The finer-grained methods below earn their complexity mainly when your RIT is heading past $60,000 or your income is genuinely lumpy.

Estimation: for the year that got smaller

You can estimate your own provisional tax instead, and re-estimate through the year up to your final instalment. Estimation exists for one main scenario: income has clearly dropped, and paying last year plus 5% would badly overpay. The catch is symmetrical: estimate too low and use-of-money interest applies to the underpayment, because estimating takes you outside the safe harbour. Estimate honestly, keep evidence of your reasoning, and treat it as a tool for down years rather than an optimisation.

The ratio option: tax that tracks your invoicing

The ratio option calculates each instalment as a percentage of your actual GST-period sales, so tax tracks income automatically: big period, bigger payment; quiet period, smaller one. Paid in six instalments on the GST cycle, and if you apply it correctly, no use-of-money interest even if the year ends short.

Eligibility is specific. You need to:

• have been GST-registered and in business for the whole previous tax year (and part of the year before),
• have previous-year residual income tax over $5,000 and up to $150,000, and
• file GST monthly or two-monthly (six-monthly filers can't use it).

It suits contractors whose income swings inside a year and whose margins are steady, since the ratio ties tax to turnover rather than profit.

AIM: pay on actual profit, through software

The accounting income method calculates instalments from your actual accounting income each period, through approved accounting software that files a statement of activity every cycle. Pay what it calculates, on time, and no use-of-money interest applies. It's the closest thing to pay-as-you-earn for the self-employed, at the price of running (and paying for) the software and its filing rhythm. For a solo contractor already inside the safe harbour, AIM usually adds process without adding protection; it earns its keep for bigger, lumpier businesses above the $60,000 line.

Choosing, in one pass

• Steady or growing income, RIT under $60,000: standard option, pay on time, stop thinking about it.
• Income clearly down on last year: estimate, carefully and with evidence.
• Lumpy income, monthly or two-monthly GST, RIT up to $150,000: the ratio option ties payments to reality.
• RIT past $60,000 with volatile profit: AIM through your accounting software, or a conversation with your accountant about which protection is cheapest.

The dates for every method this year are in the tax calendar; what provisional tax actually is starts in the hub guide.

How Coffer helps

Whichever method you pay by, the money has to be there on the instalment date. Coffer ringfences income tax from every paid invoice at your projected effective rate, shows the instalment dates with a countdown, and logs each provisional payment against the set-aside, so the dashboard always shows whether the next instalment is already covered.