What really happens when you get behind on tax | The Prosperity Project

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[00:00:00]Kilda, I'm Nadine Higgins and welcome to The Prosperity Project.

[00:00:05]>> [music] >> We're going to answer a question from one of our listeners today and [music] Terry's question is about tax or rather she has a whole heap of questions about how to manage her tax more efficiently as a small business owner and I have just the person to help with that.

[00:00:26]Katrina Nap is the principal at Future Focused Accountants. She's my accountant, full disclosure, and she is the perfect straight shooter to tackle this topic.

[00:00:36]Well, Kilda Katrina and welcome back to The Prosperity Project. So good to have you here. Before we get into some of these questions that Terry has asked, I wondered if you could give us an idea for those who haven't been in this situation, what happens when you get behind on tax? Well, several things and I think probably the biggest problem for most is the stress factor. Tax time.

[00:00:59]It's like any financial stress creates ongoing stress in life and that's the big problem. And I think a lot of people don't go to their accountants early enough and say, "Look, we're behind, we're going to get behind, we're struggling." because number of people I have come to me, they feel really embarrassed about that. And yet what we've been through with these economic times is it's been tough for everybody.

[00:01:20]So I think the big thing with tax and getting behind is actually facing it and coming up with a plan like anything in life. And once you get that plan, then you can relax and then on what's important. And often that's the business and making the business better which is then a flow-on effect to, you know, paying your tax and keeping up to date with your tax. But what does the IRD do?

[00:01:42]How nasty is it when you get behind?

[00:01:45]What are they going to charge you in penalties and interest until you manage to get square again? Yeah, it's interesting that IRD have this reputation for being bulldogs, ogres, all of those sorts of things. I I haven't Well, I don't tend to hear many people say nice things about the IRD, but the reality is and they're not paying me to say this, but the reality is is that I find as soon as you're up front with them and you communicate with them, then you've got them on side. It's like anything in life. As soon as you communicate with people and you make and you're honest with them, then again, you've got a plan and if you stick to that plan, they're okay. The thing that they don't like is people burying their head in the sand, not communicating, hiding from them, evading any messages they leave them, then of course, they get more and more elevated with what they're going to do. But if you approach them straight up and say, "Well, you know, I'm having cash flow problems.

[00:02:36]I can't meet my payment. Can I pay it off in installments?" I've never had them deny that. Where we have had problems with them is if you don't stick to it. Mhm.

[00:02:46]>> Then of course, we've got to do a lot of sweet talking with the IRD, which can be a bit of a challenge, but again, I I still find them reasonably good to deal with. So, you're having to sweet talk the taxman?

[00:02:56]>> [laughter] >> Most of the time, yes. I think it's like anything. If you If you are nice to people and you deal with them in a professional, polite, respectful way, then you get the same in return. Mhm.

[00:03:08]That [snorts] said, there's something called the use of money interest rate, right? So, if you owe them money, they are entitled to charge you interest on it. So, how steep is that? And what about if you run into actually being charged penalties? Well, that's where people get into trouble because as soon as you start getting behind and you don't enter into an arrangement with them, then the penalties go on and the penalties are quite large. So, you get 1% initially. So, if you needed to pay tax tomorrow and you don't pay, you get 1% put on straight away, then another 4% put on if you haven't paid in for um 7 days time, and then you get another 1% thereafter monthly accumulating on that balance.

[00:03:50]>> So, it's compounding. [clears throat] They're going to charge you interest on the interest. Well, they charge you penalties on the penalties and on the overdue tax. Right. So, of course, if you've got a reasonably large balance, that can accumulate quite quickly. But, what a lot of people don't realize is that if you enter into a payment arrangement with them, you don't get charged penalties. So, you'll get an upfront penalty, so you might get that 5% for that first month, but then the ongoing 1% compounding is not charged if you keep up to date with your installment arrangement. So, that's a huge thing. Obviously, you have interest charged on top of that, and their idea behind doing that is, and we can argue one way or the other whether that's fair, but their idea is that well, you've had the use of that money. You know, you've made the money, you should have paid the tax, and yes, there's a whole lot of reasons why people don't pay tax. We don't purposely avoid paying tax. There are there are reasons and bills to pay. But, as they near you, it's that well, you've had the use of that money. It should have come to us.

[00:04:46]If you'd have put it in the bank, it would have earned interest. So, of course, we expect to get that. And then you can go the next step and say, "Oh, look, the interest rate is a lot higher than what you would get if you put the money in the bank." But, of course, that's a deterrent as well. If they had a really cheap interest rate, well, then of course, people would abuse it.

[00:05:03]>> Would effectively use them like a lender. That's right. Um so, what is that interest rate? How high is it? At the moment, it's 8.97%.

[00:05:12]Okay. So, it's reasonably high. But, if you compare that to an unsecured interest rate at a bank, then it's quite likely lower than that because I think a lot of the um unsecured rates at the bank are kind of between 13 and 19% depending on either bank, [clears throat] your credit history, a whole lot of different things. So, it's higher than mortgage lending rates, whether it's commercial lending or residential lending, but at the same time, it's not too over the top when you compare it with unsecured lending.

[00:05:39]>> not a payday lender kind of rate. That's right. [laughter] And effectively, it is unsecured borrowing because they don't have any security over any of your assets, your business, anything. How hard does the IRD chase people when they do owe them money? Because I feel like I've seen loads of headlines of late where companies have been tipped into receivership and they owe the IRD heaps, like hundreds of thousands. How does it get into that position without them coming and bashing down your door and saying, "Where's my money?"

[00:06:10]There would have been a lot of letters and a lot of communication attempts behind the scenes.

[00:06:15]But I think what we've got now is yes, we've got increased activity from the IRD chasing debt because it's it's come to the point where it is a factor and I think it's also come up in political forums as well about IRD debt and how much tax is owed by people. Billions.

[00:06:30]Yes, but if you back up the truck, we've had COVID and they were very lenient with people during COVID times. So of course that bought a lot of people 1, 2, maybe even in some cases a little bit longer uh leniency. And so now we're getting to the point where they're starting to chase and if they're not getting any response, they're starting to get more intense with their chasing because they have been lenient on some in the past.

[00:06:55]Yeah, and it's difficult economic times if you're trying to pay back tax and forward tax as it were.

[00:07:02]Hard to do both at once.

[00:07:04]Yeah, I often say to people if if it's it's an 18-month recovery period if you get behind in tax if you're lucky.

[00:07:10]Because when you think any business, if you're doing well, you might be getting a profit margin of 15, 20% and I say if you are lucky and doing well, it could even be 10. So you can imagine if you get behind in your tax and your your tax is kind of 30% on your profit, then you've still got to pay bills and all these other things, pay off lending with that profit. So it can take you a good 18 months to get back on track and back up to date if you get behind and that's even if you get behind by a year. If if you have one of these people that or businesses that are more unfortunate and are behind by or three years, then of course your catch-up time is a lot longer. Mhm. Okay, let's dive into Terry's questions. Um well, actually it's a whole heap of questions, but the first one is about tax pooling. What is it and why might you use it and how can it help you stay up to date >> [laughter] >> with your tax?

[00:08:02]Well, tax pooling is a really good resource that people can tap into.

[00:08:07]And it's an independent agency that you can either pay tax into or more importantly and more beneficially, you can actually get tax from. And when I say get tax from, you can't hold your hand up and say, "Can I have some tax?"

[00:08:21]But the way it works is that if you're behind in your tax, you can pay money into the tax pool and they have tax available, usually at the due date that you should have paid it. So, how it works is that you have a lot of big businesses that might be due refunds.

[00:08:35]So, they'll make their refunds at the IRD available to the tax pool. So, rather than getting that refunded by the IRD and getting a very small rate of interest, they'll make those refunds available to the tax pool and the tax pool will give them a higher rate of interest once those refunds are used by an outside taxpayer. And so then, me being the taxpayer, I can say to the tax pool, "Can I borrow some of that money to pay my tax?" Is that Is that how it works?

[00:09:04]Well, yeah. Well, how it works is that if you owe $10,000 back in August last year and you didn't have the money at the time, then you can make a request through the tax pool to buy that $10,000 of tax at 28th of August last year.

[00:09:20]So, then they will look into the pool and they'll say, "Yes, we've got that $10,000 worth of tax that's available at the IRD as a refund to somebody else.

[00:09:29]So, if you pay your $10,000 plus interest into us, then we will pay the person that's due the refund $10,000 plus a higher rate of interest than what the IRD would have paid them. So, it's kind of Is it kind of like a finance company? It is. For tax. It's a tax finance company. And so, the way you you look at it and a lot of people at the outset say, "Oh, well, this doesn't seem quite right."

[00:09:51]But, the way it works is that the person with the tax refund gets a higher amount of interest back than what the IRD would have paid them. The person paying or short on the tax doesn't pay the IRD use of money interest at 8.97%.

[00:10:05]The tax pool will make it available to you for, let's say, 2% less than what you'd pay the IRD. But, in addition to that, you're not getting charged late payment penalties because you can use that refund that was available at 28th of August last year, rather than you charged penalties from August right through to now when you're making the payment.

[00:10:24]>> Right. So, it's a way of making being slightly behind on tax a bit cheaper, so that you can pay back faster. Very much so. And also, it gives you that if if in August you were cash strapped, it gives you that ability to actually run through and think, "Okay, I have a a really big summer forecasted. So, I know I'm going to be able to catch up by February, March, even. We are April now and next year, and I'll still be fine with the IRD because it means that I I won't be charged any penalties because I can access money from the tax pool. And yes, I'll pay interest, but I'll pay a less amount of interest, and I won't be charged late payment penalties." And as we talked about, they just accrue and accrue each month. And is it particularly useful then when you're talking about, you know, I've got a big summer coming for seasonal businesses that at certain points in the year when the tax is due, there's no money in the kitty, whereas they know that cash is coming, it's just not here now.

[00:11:20]It's It's really useful in those situations. And I've got some larger clients where they actually just want to sit and forget their tax simply because it is quite a large number if if add it up over the course of the year, and they're fortunate enough to get income for 10 months of the year. So, what we do is we say, "Well, okay, on average, you need to pay $200,000 tax across the course of the year, but we want to pay that over 10 months.

[00:11:45]So, what you're going to do is you're going to pay $20,000 a month into the tax pool, and then you know by the end of the financial year you've paid enough." So, they can match it with when the income's coming in, and they don't pay any tax in those 2 months when it's not, and then behind the scenes we can work it all out with the tax pooling agency in conjunction with the IRD, and everyone lives happily ever after.

[00:12:06]And that's what we want. We need to take a quick break, but after that, Terry has some questions about utilizing your mortgage when you're saving for tax.

[00:12:14][music] So, we'll get into that right after this.

[00:12:20]>> [music] >> Welcome back to the Prosperity Project.

[00:12:22]We're talking about tax and how to manage it better, especially for small businesses. And we've got some great questions from one of our listeners, Terry. We've talked about tax pooling.

[00:12:32]Next on her list was, "Does it make sense, you know, when I've set aside my tax, ready to pay it in 3 or 4 months' time, that I put that on, say, my mortgage, and save myself some mortgage interest until it's due? What's your take on that sort of strategy?" I think from a pure financial management point of view, it's a great idea.

[00:12:56]But what you find practically is that when money goes on people's mortgages, they get all excited about the fact that their mortgage is going down. And then you have people like us that are referred to as the Grim Reaper half the time because [laughter] we then come along and say, "Actually, you owe this amount of tax," and they don't want to pull it back off the revolving credit mortgage because for them it feels like they're going backwards. So, technically workable, psychologically a bit of a wrench. Very difficult at times. [laughter] And some people can get their head around it, and of course they benefit from it. And also where you get a really big benefit is let's say you started business this year.

[00:13:30]Well, there's I guess the the fact that or the fable that actually is is that people think well you get your first year free of tax because of course it's not till you file your first tax return and you realize how much tax you've got to pay and then you've actually got another or till April the following year to pay it. So a lot of people think yay, this is great, you know, we're making all this money and um sadly some go and spend it but the the good ones will actually set aside that money. So you can imagine if you're setting aside your tax savings and you've got let's say a good 18 months before you're going to have to pay it to the IRD without interest, penalties, anything because until you file that first tax return they don't know you're making money. So you don't have to pay any tax theoretically. It just catches up with you. But if during that time you put that on your revolving credit mortgage, you could get quite a benefit for that. So that can work quite well.

[00:14:18]So there's a there's a magic window in your first couple of years in business but after that I guess the window is shorter cuz the tax tends to be due fairly regularly. So I guess that must water down the benefit of it and if you are likely to then go and spend it, maybe it's not for you.

[00:14:34]>> [laughter] >> Well, that's right. I think uh on average it probably works for being generous 5% of the taxpayers out there, probably no more in my experience.

[00:14:43]Obviously there are other people with different experiences but that's what I find. And one of the big factors like we've mentioned is the psychological factor and you balance that off with the fact that it doesn't probably save you a lot of money on interest because the periods are so short. So every four months you're paying tax. So the interest that you're going to save on your mortgage over that four months period unless it's a considerable amount of money is quite small.

[00:15:07]But others do it in a really good way where they've they keep their personal mortgage aside and they'll have a separate revolving credit facility that they know their tax savings is going into and they know that they're going to be drawing that down to pay tax at the time. So So you can label it tax, do not touch, and still get the benefit of offsetting the interest. That's right.

[00:15:27]And a lot of the banks I'm finding these days have what they call those offset accounts, which can work quite well as well. So you can put your tax savings into what is still a tax savings account, but you have the benefit of it being being offset against your mortgage. And I think that's really really smart thing to do often. Yeah, you [clears throat] just have to brace yourself for when your lovely Grim Reaper accountant comes to you and says, "Time to pay up."

[00:15:49]>> That's right. Um Terry's other question was, "If I'm not going to put it against my mortgage because maybe that's psychologically too difficult, could I instead put it into some kind of short-term investment?" And I'm presuming that they do not mean you know, riddle black in the share market or down at the casino. Um but, you know, like a fixed-term product like an um you know, a term deposit or a you know, some kind of um notice saver where it's fixed interest and whatever.

[00:16:18]What What do you make of that kind of idea?

[00:16:20]Again, you can and you will earn a little bit of interest on that.

[00:16:26]But in many cases, particularly I mean, not so much with your term deposit because you know you're going to get a fixed return on that. So that can be quite good because you're earning a little bit of interest. But again, it comes down to the amount and is it really worth the bother? Particularly if you can do like what we talked about with an offset account, which might benefit you even more. You've also got the mechanics of setting up the term deposit and withdrawing it and all of those things.

[00:16:50]>> the return on the term deposit, so it becomes a tax merry-go-round. That's right. And often your gain is so small, it's not worth the bother. It's not Not like in the past where you could send a quick email and something would be invested and send another email and it would come back if you needed it. There are a few more hoops to jump through these days for varying reasons. The other thing, if you go one step further and let's say put it into a PI fund for a small period of time, then you're at the mercy of the market. So if you put it in and it's worth a certain amount of money and then the market does a nosedive because uh we have all kinds of international events that we can't control, then uh all of a sudden your tax savings have depleted by what's gone on internationally that you you can't control. So, often the short answer to that is not the best idea. Uh and again, it took it's about quantum, isn't it? Because the more money you've got, the more advantage it may have for you, but more often than not, if you're talking about you know, most taxpayers, we're not talking about a lot of money that's going to make a big difference if you're talking about the income you'd earn in that period.

[00:17:51]>> So, you're kind of tinkering at the margins. You might do better to actually just focus on growing your business and leave that to worry about itself.

[00:17:58]>> That's right. Spending the time trying to make a bit more money is probably going to give you a better return than worrying about that kind of thing.

[00:18:04]Now, we need to take a quick break, but after that, Terry has a question about provisional tax, which I know can be the bane of some small business owners' lives. Uh we will get to that right after this.

[00:18:19]>> [music] >> Welcome back to the Prosperity Project.

[00:18:21]We're talking about tax, and as I say, the only certainties in life are death and taxes, which is pretty crummy. You probably hear that one all the time, Katrina. I do. I do.

[00:18:28]>> [laughter] >> Um but our listener, Terry, has come to us with a list of questions, and one of them is about provisional tax. Okay.

[00:18:35]They'd like to know why 10% gets tacked on top um in the in the year on the money you haven't earned yet.

[00:18:43]It's always interesting to think about those sorts of again, percentages and why it's it's like a lot of generic percentages that are applied, but I think where the idea coming from is that the expectation is that most people in business grow their revenue. That's what you set out to do, and those that are successful do grow, and some beyond that 10% level. So, it actually means that that that 10% is not enough.

[00:19:07]>> So, they're underpaying if they're going great guns. And that's right. So, and also, it's 5% of your tax return for the prior year has been filed already. So, those that get in and file their tax return, let's say before August every year, then their first provisional tax payment for the following financial year is going to be based on the previous year's amount plus the 5% rather than 10. So, 10 is only if you're going back the year before last and basing the tax payments off that. But, like I said, it comes down to just the phenomenon really that every business is going to grow and we can debate that based on what's happened perhaps here in the last 5 years because that hasn't always been the case. But, then I challenge people and say, "Well, that's where your accountant needs to be communicating with you and you communicating with them about where your revenue is at because in most cases your accountant will have a look at how you're going for each provisional tax installment and come to you and say, "Well, this is what the IRD are expecting you to pay.

[00:20:04]This is how your business is going. This is tax on your year-to-date income. If we've got a difference, either if it's more, then you know you need to save more. If it's less, then you've got in your mind, "Look, if I pay the higher amount now, maybe I can reduce either the last installment of provisional tax that I pay or the second installment that I have to pay." So, can you adjust them based on how you're going or is the IRD then going to say you're actually behind on your provisional tax even though you know your business isn't doing so well this year?

[00:20:33]You can adjust it. There are a couple of mechanisms for that. One is you can file a formal estimation and reduce it.

[00:20:41]Another is that you just pay less.

[00:20:43]And if that ends up correct at the end of the year, then happy days, you know, everything's good. If you end up short paying, then again we come back down the penalties route and the interest route and all those sorts of things. But, then you've got the tax pooling agencies that you can use. So, that's where tax pooling works out really well for a lot of businesses because again, if you think, "Heck, we've had a terrible first quarter. We we can't afford to pay as much. we don't think the year's going to improve, then you can pay less knowing full well that hey look, if we do better, we can go back and catch it up.

[00:21:14]Mhm. What about the AIM method, the accounting income method?

[00:21:21]Who is that appropriate for and how does that compare to paying provisional tax?

[00:21:26]Essentially, it's the same as paying provisional tax but every two months.

[00:21:31]So it's just more frequently, so you kind of have a better read on how things are going. That's right. And the good thing with AIMs, well I think it's a good thing, is that you are paying tax on your actual income for the year to date. So every two months, you're filing a mini tax return and the amount of provisional tax you pay or your amount of tax you pay is based on your profit for that two-month period. So if you're a seasonal business, and particularly for those that start off the year, let's say winter's your low and summer's your busy time, then for a lot of those businesses that August period and that August payment is quite tough. Whereas if you're on the AIM method, then you're paying very little um or some cases if you're not making any money, you're not making any payments until you start to make money. And then of course your payments are going to be quite large if you make the lion's share of your revenue over let's say the last five, six months of the financial year. Yeah, which must be heaps, you know, if you go through the tourism industry and the horticulture industry, loads of people are making the majority, hospitality even, over that kind of Christmas, New Year, summer period. And even construction. You you think that's a large part of key businesses is construction or some flow-on effect or trade-based businesses associated with that. And while we all like to hear relatively consistent levels of earnings, that isn't always the case, particularly if there's milestones that need to be achieved. So that's where AIM can work quite well because if you've had a very low billing two months and you don't pay much tax.

[00:22:55]But the big advantage I find with AIMs, and that's why a lot of clients that I put on it stay on it, is because they know that they're up to date with their tax. And psychologically, that means a lot because they know that after they've paid their aims payment, what's in their bank account is their money. So, they can use it to pay off some mortgage, they can go on a holiday, they can invest it in growing the business, but they know that they're completely up to date. One of the big things with tax is it's that stress about I'm going to get a big bill that I'm not expecting. So, that takes that away and it works out really well for most people. Do you have any kind of rules of thumb that you tend to follow? Is it like, you know, put away 40% or, you know, uh lock it up in a separate account or are there some key ways that if you just focus on those basic things rather than worrying about putting it against your mortgage or whatever, that you're going to be okay?

[00:23:42]There's lots of ways you can work it out. I mean, a very easy way to work it out is simply taking last year's tax that you have to pay and dividing that by your income and or your revenue, and then you've got a percentage of the amount that's going into your bank account every month that you need to then save for the following year.

[00:24:00]And a lot of people start off by saying, "Oh, we'll save 30% or 35 and and, you know, that should cover it." And often it does. In more cases than not, because you have expenses, then you end up with a little bit extra saved, and that's quite nice because then you have some spare money at the end of the year that you can invest into something, you can pay off some debt, all of those sorts of things. What I find that the trickiest is that we can say to people, "Look, try and save 30, 35% if you can."

[00:24:27]But when cash flow's tight because people don't pay you, then having to pay or save that 30% becomes really difficult. So, people save nothing. And then we get, you know, 6, 12 months down the track and there's no savings because people give up, and that's where it's it's hard. So, I always say to people, and having an upfront conversation is that if the savings is going to be difficult, even if you save 20% to start with, you know, like the goal is 30, 35, let's say, but even if you save 20, at least when you get to the end of the year or when a tax payment's due, you're going to have some of that money. Mhm.

[00:24:59]You said at the beginning that people don't set out to avoid tax.

[00:25:03]I suppose some people do. But also, it's it's legitimate right to manage tax or minimize tax. It's not legitimate to avoid tax.

[00:25:12]>> That's right. What's the difference though?

[00:25:15]>> [laughter] >> Well, that's a million-dollar question, isn't it?

[00:25:19]I think in a lot of cases people avoid tax when they get tight with financially.

[00:25:26]That's That's what causes it is other pressures. Again, like I said, I I don't fundamentally believe that most people set out not to pay tax. We all want to minimize the tax that we pay, and I don't think there's anything wrong with that, provided you stick within the guidelines. But it is about actually trying to manage that tax obligation in line with your business cash flow. And of course, if cash flow is not great, and it means that you can't meet your tax obligations, then you need to talk to your accountant about how you can manage that better. Maybe there's other things that you've got to look at in your business in terms of payment terms, uh the the type the way that you bill, maybe you need to bill a little bit up front so that you've got that cash. So, I think if things aren't working, and consistently you can't pay your tax, it's not about burying your head in the sand, it's about getting help from the right people to say, "How How can I change what I do so that I can keep up to date with my tax, and at the same time keep running my business the way I want to run it?" Yeah, there's no point burying your head in the sand because they will catch up to you eventually, right? No, they're even starting to doorknock at the moment. Have you Literally? Yes.

[00:26:27]>> I mean, you get plenty of chances, lots of phone calls, lots of letters. So, they're not just going to arrive while you're having your Sunday dinner, but they are doorknocking if you don't respond. And is Are they just outsourcing that to Baycorp, you know, and they're literally got a debt collector on the doorstep or It's the IRD officers themselves that that uh you know, that are responsible for chasing that particular client. Wow.

[00:26:50]>> Mhm.

[00:26:51]Well, I guess on behalf of everybody else who benefits from the schools and the hospitals and the roads, we need you everyone to pay their tax. We do.

[00:26:59][laughter] And like you say, there's there's only one thing that's certain or two things, death and taxes. And uh none of us like it. And I think for me in my experience over the years, it's just about taking that pain away. It's about realizing none of us want to pay it. How are we going to make this process easy? Is it using the Aim system so that we know that you know, what we've got in the bank account every 2 months is ours? Is it using a tax pooling and and paying a certain amount a month in that over the months that we've got the cash? You know, how are we going to do it so that it's easy for us and it's a set and forget? Because ultimately, you're going to do better in your business if you're focusing on generating revenue and not focused on minimizing tax, avoiding tax, and getting stressed about not being able to pay tax. Yeah, I love your pragmatic approach as always. Thanks so much, Katrina. It's all right. Thanks for having me along.

[00:27:49]Thanks for joining us on the Prosperity Project. For more personal finance coverage, visit nzdherald.co.nz.

[00:27:56]And just a reminder, this podcast is for informational purposes only and doesn't constitute personal financial advice.

[00:28:03]Always do your research or talk to a qualified advisor before making decisions about your finances. [music]