Understanding Tax: Use of Money Interest (UOMI)
Last time on our blog we discussed Terminal and Provisional tax. The fun is not yet over… this week we thought we might tackle Use of Money Interest, or for short, UOMI. So what is UOMI? Use of money interest is the IRD charging you interest on the tax you have underpaid, effectively trying to discourage you from using them as a bank. In their eyes, you have had the use of the money when you shouldn’t have had it, and as such it stands as an outstanding payment with them. When does it get charged? This question is a little bit trickier. Let’s look at our fictitious company, The Mad Scientist again. Remember how, for example one, in their second year they still had terminal tax to pay? They’d paid provisional tax of $29,400, but their total (residual) tax to pay for the year was $42,000. This meant that they still had $12,600 in terminal tax to pay. Well, in the IRD’s eyes, this means that they’ve had use of that money, when they shouldn’t have had. They believe that the company should have kept an eye on their profit, and adjusted the provisional tax they were paying as the year went by. For companies, if their residual tax for the year is $2,500 or more, and they have terminal tax to pay, then they will get charged UOMI on that amount. For individuals, the IRD is not quite so strict. If your residual tax to pay is under $50,000, and you were not aware you should be paying provisional, or you have paid the provisional tax that was calculated automatically from your previous year’s tax return, then you won’t be charged. However, if your residual tax is over $50,000, or you have estimated your own provisional tax and it was not enough to cover your residual tax, then you will also be charged UOMI. How do they calculate UOMI? Let’s again use The Mad Scientist as the example. As already discussed, as they have terminal tax to pay of $12,600 within their company, they will have UOMI to pay on that amount. The IRD calculates UOMI by saying that the total tax should have been paid throughout the year as provisional tax. This means that in their eyes, The Mad Scientist should have paid $14,000 at each provisional tax date. However, they only paid $9,800 on each of these dates, so the IRD charges interest at 8.27% (changed on the 8th May 2016) on the leftover amounts, from the dates it should have been paid till when it is paid. Let’s assume this is the terminal tax due date of the 7th of April the next year. For example: Provisional Tax Dates 1/3 of Residual Tax ActuallyPaid Leftover Days Overdue UOMICharges 28th August 14,000 9,800 4,200 587 $558.60 15th January 14,000 9,800 4,200 447 $425.37 7th May 14,000 9,800 4,200 335 $318.79 Totals: $42,000 $29,400 $12,600 $1,302.76 For smaller companies that may not be earning so much these charges may not amount to much. But if your company is starting to grow their profit, UOMI can be an unwanted sting. So how can you avoid UOMI? The best way to do this is to keep an eye on your profit as the year goes on. Also, UOMI works both ways. So if you happen overpay and end up with a refund at the end of the year, you will get interest back on it as well since the IRD has had use of your money. Of course, the interest rate is much lower when the IRD owes us – 1.62% in comparison to 8.27% – but at least it’s something. But if you don’t want to make wild stabs in the air as to how much provisional tax you are paying, talk to your accountant. Not only can they help advise you on this as the year goes by, you will also have a better idea on how your business is going, and be building a stronger relationship with your accountant. According to Xero’s research, this is a very good thing. Their research suggests that having a strong relationship with your financial adviser is good for your business. We agree. Here at MHCo, we strive to create, and maintain, strong relationships with all our clients. After all, their success is our success. So stop worrying about tax, and UOMI, and come talk to us. We’ll do our best to make tax easier to understand, and take the weight of not knowing off of your shoulders. Thanks, the MHCO team.
Understanding Tax: Terminal vs. Provisional
Tax. It’s the dirty word all business owners flinch at. Newcomers stress about that second year hit, and everyone winces when the lump sums leave their bank accounts. But how many business owners understand tax? And how many newcomers know what to expect? We thought we’d put together a blog breaking down some of the basic facts about tax. That way, maybe, when you next hear the word you feel a little more prepared to face it. The Second Year Sting How many business owners have been warned about the tax hit, come their second year of business? In their first Financial Statements meeting we’ve heard many express their worry over it. After close to a year of trading without worrying about tax, suddenly the shadow of it looms over them and they can’t focus on anything else. How well their business is going, or how they could improve upon it, falls on ears deafened to all but tax. But what causes this second year sting? Terminal + Provisional Tax If trading has gone well, a new company will have a full year of profit to be taxed. On top of that, if they have done well enough, the IRD now also expects them to make instalments towards the tax they are going to have to pay for the coming year. This means that effectively they are paying two full years of tax in one. For the year that’s just been, they will be paying terminal tax. For the year that is still happening, they will be paying provisional tax. Terminal Tax Terminal tax is the wash-up tax, based on the tax return detailing the final profit for the year just been, the last tax instalment for a finished financial year. In the first year of trading it is the total tax to pay on that profit. But in other years the terminal tax is the leftover tax to pay on the total profit after provisional tax is accounted for. Provisional Tax Provisional tax is tax that the IRD asks you to pay for this year based on your historical profit as the year progresses. You are only required to pay provisional tax when your total tax to pay for a year is greater than $2,500. When this happens, the IRD estimates that for the coming year your profit will grow by another five percent, and instead of waiting for a full year for you to pay that tax, asks you to pay the tax on your profit as you earn it – PAYE for your business in a sense. Let’s break it down further. To do this, we’ll use an example of a fictitious company, The Mad Scientist Limited. In this example we will ignore Use of Money Interest, but please keep watch for our next blog post! The Mad Scientist Limited – First Year The directors at The Mad Scientist have had an excellent first year in 2016. After hunting down every opportunity they have ended up with a profit of $100,000 in their company. This means that the total tax they have to pay on their profit for that year is $28,000. As they have not paid any tax so far, this full amount is due as terminal tax on the 7th of April 2017. Because their total tax to pay is over $2,500, the IRD now expects them to begin paying provisional tax as they go while they are still earning their profit for the year – much like PAYE is paid as a salaried worker earns their wage. However unlike those on a salary, the IRD won’t know till the end of the year when the company’s tax return is filed exactly what the profit is. Instead, the IRD assumes that The Mad Scientist will grow by another 5% to earn $105,000 profit the next year. Based on this profit the total tax to pay would be $29,400, and the IRD splits this into three equal amounts during the year for you to pay, $9,800 on the 28th August 2016, 15th Jan and 7th May 2017. The Mad Scientist Limited – Second Year Example One: Let’s assume that The Mad Scientist completely exceeds the IRD’s expectations, and manage to increase their profit by 50%, earning $150,000 in their second year of business. This means that the total tax to pay on that profit for 2017 is $42,000. Remember that they have already paid $29,400 in provisional tax for 2017. This means that they only have $12,600 left to pay in tax, and this is called Terminal Tax to pay for that year. Once more, provisional tax is calculated based on a 5% increase on $150,000. Then $44,100 in tax is divided into three payments of $14,700 during the coming year. Example Two: But what if in the second year of business The Mad Scientist flounders? This year their profit doesn’t even break $100,000, and they only make $80,000. Based on this, their total tax to pay is $22,400 for 2017. However, due to Provisional tax, they’ve already paid $29,400. What happens now? As they’ve overpaid their tax by $7,000, they will receive this amount back as a refund. This means that for their second year of trading they won’t have any terminal to pay at all. They will still have provisional tax to pay however for the coming year, and this will be based on $84,000 in estimated profit. To Conclude Terminal tax is the wash-up of the tax for the year just been. Provisional tax is paying for the profit you are currently earning. As for Use of Money Interest? I think we’ll leave that till our next piece! Thanks, the MHCO team.