Key takeaways

  • Provisional tax is income tax paid in advance, in three instalments through the year, based on what you earned the year before.
  • You enter the system if your residual income tax was over $5,000 in the previous financial year.
  • For a 31 March balance date, instalments under the standard method are due 28 August, 15 January, and 7 May.
  • The second-year trap: you can owe last year’s terminal tax and this year’s first provisional instalment in the same window.
  • Setting aside 25-30% of your income from day one is the simplest way to avoid the cash flow shock.

It can be a serious cash flow hit if you are not ready for it. Understanding how the system works is the first step to staying ahead of it.

What is provisional tax?

Provisional tax is income tax paid in advance, in instalments throughout the year, based on what you earned the year before. It is IRD’s way of collecting revenue from businesses during the year and making sure you do not end up with one massive tax bill at year-end.

For salary earners, PAYE handles this automatically. Tax comes out of every pay packet. For self-employed people, there is no equivalent, so IRD asks you to estimate and pay through the year.

Who has to pay provisional tax?

You enter the provisional tax system if your residual income tax (the tax you owe after all credits and deductions) was more than $5,000 for the previous financial year. This usually kicks in from your second year of trading, because IRD needs your first year’s results to calculate it.

In your first year, you pay no provisional tax because there is no prior year to base it on. You just pay terminal tax at the end of the year. In year two, that is when both bills can land at once.

However, if you have residual income tax in your first year of $60,000 or more, you will be required to have paid this by the third provisional tax date of 7 May. This level of tax is known as the safe harbour threshold, requiring that taxpayers above it are on top of their tax payments. If you expect your business activities to earn over $180,000 profit in your first year, then it’s important you speak to an adviser to discuss any potential provisional tax requirements.

How is provisional tax calculated?

The standard method takes your previous year’s residual income tax, adds a 5% uplift, and splits the result into three instalments. For businesses with a 31 March balance date, those instalments are due on 28 August, 15 January, and 7 May.

There are other methods you can choose:

  • Estimation method: you estimate your current year’s income and pay based on that. Useful if your income is dropping and you do not want to overpay.
  • Ratio method: payments are based on a percentage of your GST taxable supplies. Available if you are GST registered and meet certain criteria.
  • Accounting Income Method (AIM): uses real-time data from approved accounting software to calculate smaller, more frequent payments. Designed for fluctuating income.

The standard method is the simplest and the default. The other methods are worth considering if your income varies significantly year to year. However, underpayment of provisional tax can result in Inland Revenue charging Use of Money Interest, so it’s important to get this correct.

What is the second-year trap?

In your first year of business, you pay no provisional tax. Then in your second year, two things can happen at once.

You owe the terminal tax from year one (paid by 7 February if you self-file, or 7 April if you use a tax agent), and you start paying provisional tax instalments for year two. If your first year was profitable, that can mean paying around 18 months’ worth of tax in a compressed window.

The only way to manage this is to know it is coming and set money aside from day one. A common rule of thumb is to put 25-30% of your income into a separate savings account for tax. That way, when the bills arrive, the money is already there.

When are the provisional tax due dates?

For a standard 31 March balance date, the three instalment dates are:

  • 28 August: first instalment.
  • 15 January: second instalment.
  • 7 May: third (final) instalment for the previous tax year.

The 7 May instalment is the last payment for the year that ended 31 March. After that, terminal tax catches up any shortfall (or refunds any overpayment) once your tax return is filed and assessed.

If you are 6-monthly GST registered, your provisional tax dates will align with your GST payment due dates.

What happens if I underpay or overpay?

If you underpay provisional tax, IRD may charge use-of-money interest on the shortfall. The rate moves with market conditions, but it has been substantial in recent years (around 9% in 2026, and higher in the year before that). Check IRD’s current rate for the up-to-date figure.

If you overpay, IRD pays you interest on the surplus, but at a much lower rate. The system is designed to penalise underpayment more than it rewards overpayment.

There is a safe harbour rule: if your residual income tax is under $60,000 and you have paid all instalments under the standard method, use-of-money interest is only calculated from the terminal tax date, not from earlier instalment dates. That gives most small businesses meaningful protection from interest charges.

Can I reduce provisional tax if my income drops?

Yes. If you can see that your current year’s income is going to be significantly lower than last year, you can use the estimation method. You estimate your current year’s tax, and pay one third of that estimate at each instalment date.

The risk is that if you underestimate, you pay use-of-money interest on the shortfall. The estimation needs to be reasonable. If your income holds up better than you forecast, you owe more at terminal tax time, plus interest.

How does Afirmo help with provisional tax?

Afirmo’s real-time tax calculations show your estimated income tax liability as it builds throughout the year. That means you always know roughly where you stand, and you can plan for provisional tax payments well in advance.

It also flags when your residual income tax is approaching the $5,000 threshold, so you know you will be entering the provisional tax system the following year. No surprises, no scramble.

Frequently asked questions

Do I pay provisional tax in my first year of business?

No. In your first year you only pay terminal tax once your IR3 is filed and assessed. Provisional tax kicks in from your second year, based on your first year’s residual income tax. This is why the second year often feels much heavier than the first.

How much should I set aside for tax as a sole trader?

A common rule of thumb is 25-30% of your business income, depending on your tax bracket. Sole traders earning up to around $53,500 can usually get away with 20%, while higher earners should aim for 30-33%. Reviewing your real-time tax estimate and adjusting is more accurate than a flat percentage.

Can I pay provisional tax weekly or monthly instead of in three instalments?

You can pay any instalment in advance or in smaller chunks if it suits your cash flow. The deadlines (28 August, 15 January, 7 May) are when each instalment must be fully paid. Some people prefer to drip-feed payments through the year to spread the load. Using Afirmo tax wallets means you can have money set aside for taxes without paying this early to Inland Revenue but kept separate from your usual accounts that you can dip in and out of.

What is the difference between provisional tax and terminal tax?

Provisional tax is paid in instalments through the year based on last year’s figures. Terminal tax is the final balancing payment (or refund) once your actual tax return for the year is filed and assessed. If your provisional payments covered your liability, terminal tax is zero. If they fell short, terminal tax tops it up.

Afirmo shows your provisional tax position as it builds, so each instalment is planned not panicked. Start a free trial at afirmo.com.