Why pay Inland Revenue your provisional tax - when it's cheaper to wait?

A sharp rise in interest rates has many taxpayers weighing up whether to incurr a 5 per cent penalty instead of the now much-higher cost of borrowing to settle their bill with IRD. Photo / NZME

Recent rises in interest rates, coupled with the removal of interest charges on some late tax payments, mean that hundreds of thousands of taxpayers are probably financially better-off if they don't pay Inland Revenue on time.

Tax experts say the combination of pandemic-related tax cushioning and the spike in the cost of commercial borrowing threatens both the Government's tax base and the integrity of the tax system.

A recent tax omnibus law passed by Parliament in March included tweaks proposed by Inland Revenue officials which expanded "safe harbour" provisions by scrapping interest charges for taxpayers who underpaid or were overdue in paying provisional tax.

The move was intended to spare taxpayers who were a few days late, or a few dollars short, from significant interest penalties. Late payments are still subject to a 5 per cent late payment penalty, which at the time, Inland Revenue officials believed was enough to ensure widespread compliance.

But the subsequent sharp rise in interest rates now has many taxpayers weighing up whether it is better to weather that 5 per cent penalty instead of incurring the now much-higher cost of borrowing to settle their bill with the taxman.

The first tranche of provisional tax payments for the March financial year are due this week, but the safe harbour provisions could result in these being delayed until the terminal due date in February 2024 before they attract any interest penalties.

Weekend Herald calculations suggest that for those on the 28 per cent company tax rate, wearing the late payment penalty makes financial sense if a taxpayer's cost of borrowing is 7 per cent or higher.

Among the major retail banks' advertised business overdraft rates, Kiwibank's is the lowest at 7.5 per cent.

A spokesman for Inland Revenue was this week keen to stress that "taxpayers continue to have a legal obligation to make tax payments on the due date", but acknowledged that taxpayers had long had "commercial choice" about who to pay and when.

The spokesman said Inland Revenue was monitoring the situation closely and acknowledged the rise in interest rates had changed taxpayers' calculations.

"Where taxpayers deliberately delay the payment of tax, we would need to look at other mechanisms to ensure taxpayers are appropriately incentivised to pay on time," the spokesman said.

Inland Revenue says it is monitoring repayment rates following concerns recent rate hikes make it financially worthwhile to delay paying tax. /PHOTO NZ Herald by Janna Dixon

The safe harbour provisions apply to provisional taxpayers with annual tax liabilities of less than $60,000. According to Inland Revenue, last year 278,000 taxpayers - individuals and companies - were in this category, paying $5.1 billion in income taxes. That raises the risk of Government coffers being significantly short in the coming year.

National Party MP Andrew Bayly said he was in the difficult position of being spokesperson for both revenue and small businesses. He said he supported the safe harbour expansion in select committee, but the winds had since changed.

"Perversely, the solution has been caught out because interest rates have risen so quickly," he said.

Bayly feared current circumstances could trigger a rise in tax debts: "We want people to pay tax on time, but once this is widely known, this will result in more people deferring tax."

Revenue Minister David Parker says taxpayers continue to have a legal obligation to make tax payments on the due date. Photo / Mark Mitchell

Auckland University professor and tax law specialist Craig Elliffe said while the removal of interest for late provisional taxpayers was well-intentioned, the changing business climate had created perverse incentives that should be of "serious concern" for both Inland Revenue and the Government.

"When the system incentivises taxpayers to delay their payments there are obvious cashflow implications for the Government," he said.

Taxpayers intentionally increasing their levels of tax debt also raised contagion risk, Elliffe said.

"The discipline of regular tax payments spreads the burden for provisional taxpayers and reduces the risk that the taxpayer will get into financial difficulties and not be able to pay the final lump sum."

Elliffe said the state of affairs required urgent action. "I think this is a matter that requires a quick and measured response," he said.

The issue probably requires a legislative fix, and Bayly said he was open to working with Revenue Minister David Parker in Parliament to resolve matters.

"We'd fully support any changes to deal with this issue, and we will work with the Government to make this happen," Bayly said.

Parker deferred to Inland Revenue officials in answering detailed questions about the issue, but said more generally: "Taxpayers continue to have a legal obligation to make tax payments on the due date. Officials, as always, are monitoring any behavioural changes and will provide advice to Government where required."

Mike Shaw, of tax advisory firm OliverShaw, said the current state of affairs was extraordinary and needed fixing before late payments became widespread.

"This is a strange result and I hope taxpayers still pay their tax even though it is cheaper not to pay your tax," Shaw said.