Cash flow, tax conversations give rise to questions

THERE have been many conversations between advisers and clients throughout this lockdown period.

Most of these discussions are around cash flow and how to sustain and manage the lifeblood of any business.

This often leads to a discussion around tax payments. As these payments tend to be irregular and lumpy, they have a significant impact on cash flow.

In recent times in my conversations with clients there have been three themes or questions that arise:

Why is there still a significant provisional tax payment due on May 7, 2020?

This is because the payment is the third and final instalment of 2020 provisional tax for March 31 balance date taxpayers.

If the taxpayer had a businessasusual year, which many have as Covid19 didn't really have a significant impact to March 31, 2020, then this payment is appropriate.

In theory, this income has been earned and the cash should be available to pay the tax. However, theory does not match reality.

Cash has been required to pay staff, the landlord and other creditors without having a regular cash income stream from which to pay these costs.

So this payment is real and will not go away. This can be managed through negotiating a repayment plan with the IRD or funded through debt or reserves but it needs to be paid.

Is the loss spreadback scheme going to work for me?

When talking through expectations, many at this stage do not expect to be in a loss position. Business owners being entrepreneurial and perhaps being more accepting of risk are often also optimistic. Hopefully, when out of the various levels, there will be 10 months of the 2021 year remaining. This leads to a discussion if revenue in April and May can be made up. This generally results in a conclusion of none or perhaps some.

If we take an example of a taxpayer who had $100,000 income in 2020. Many at this stage expect 2021 to be well back. They are optimistic that the business may break even in 2021.

So the taxpayer at this stage is not anticipating a loss of $100,000 where at this level of loss the scheme works best to have all 2020 tax paid refunded.

However, if 2020 results in $100,000 of income and 2021 results in nil income there is no benefit in this scheme as it does not take the overall profit across two years and allocate half to each year.

What about tax payments for the 2021 income tax year?

After discussing the first two questions and realising that there may only be limited relief for tax payments, we move to a discussion to consider 2021 income tax obligations.

With provisional tax generally being based on the previous income year this will create issues with required payments being unrealistically high.

If we take the example above where in 2020 the taxpayer (let’s assume it’s a company) had $100,000 of income.

We can be almost certain for every business taxpayer that 2021 income will be lower than 2020. But under current rules there is an expectation that provisional tax is paid at 105% of the prior year amount. Income tax for 2020 on $100,000 for a company requires total tax paid of $28,000.

Provisional tax is paid in three instalments, the first being on August 28, 2020 (for a March balance date). In this example a payment of $9800 will be due. The usual way to reduce this obligation would be to make an estimate of 2021 profitability before making the payment.

This would be a situation where almost every business taxpayer would be seeking to make a downwards estimation.

There are costs and consequences associated with estimations that in the current environment would be unnecessary. These would continue to add to the stresses that SMEs are facing on a daily basis.

At this point there has been no announcement regarding the calculation of 2021 provisional tax. In these difficult times businesses need some certainty regarding their tax obligations, and we would hope to hear some announcement soon regarding 2021 provisional tax.

Henry van Dyk is a partner at Dunedin firm Polson Higgs.