Is the GST ratio method right for you?

For some taxpayers approaching the start of their 2009 income year, a new option for calculating 2009 provisional tax becomes available. In a nutshell the GST ratio method calculates provisional tax payments by applying a (pre-determined) ratio to two-monthly taxable supplies. In essence your provisional tax payments will better match cash flow. So is this method right for your business? Provided you first meet the eligibility thresholds, it may be worthwhile for some taxpayers to consider, particularly since adopters will not be exposed to the use of money interest [UOMI] regime. In fact it may be worthwhile for companies that are still in infancy to consider this as an option in the early years until their business grows beyond the eligibility thresholds.

The method is targeted at small business and hails from the 2003 discussion document “Making tax easier for small business”. Some businesses were concerned that tax payments did not match the income earning process. Seasonal businesses in particular felt it was difficult to budget for provisional tax payments. Many were also concerned about the exposure to use of money interest if they got their provisional tax wrong. In the document it was stated that 48% of those small businesses surveyed indicated they would take this option up if it were provided. And so it has been provided but what of the take-up rate? Like any method there are pro and cons but we think it is worth a closer look for some businesses who until now may have written this option off. In this article we take a look at some of the issues to think about.

Are you eligible?

The first step is to work out whether you are eligible. You may use this method, if in the preceding income year:

· Residual income tax (RIT) was more than $2,500 but no more than $150,000; and

· You were registered for GST for the whole of the previous income year and the previous year was not a year in which a taxable activity was commenced; and

· The ratio of RIT to total taxable supplies was between zero and 100%.

Where the base amounts such as RIT and taxable supplies for the preceding year are not known (most likely because last year’s return is not yet filed) there is provision to base these amounts on the assessments for the year before the preceding year.

For the current year you will also be required to file GST returns on either a 2-month or 1-month basis. If you decide you wish to use this method there is a requirement that you inform Inland Revenue of this election before the start of the income year. Thus in order for a taxpayer with a March balance date to elect for the 2009 income year, the Inland Revenue must be notified by 31 March 2008.

The mechanics

Once you have elected, Inland Revenue will calculate the ratio and inform you of this based on assessments made. Inland Revenue will be required to adjust this ratio subsequently if base amounts are revised through amended assessments of either income tax or a change in the value of taxable supplies. There is also an option to adjust the ratio for asset disposals (that meet a certain threshold) bearing mind that if these supplies are included in taxable supplies, the ratio might not accurately reflect provisional tax payable to the extent receipts are on capital account for income tax purposes.

There is a slight complication to be aware of for the 2009 year and 2010 income years for companies that adopt this method where the base amount refers to RIT from the 2008 income year. This is due to the drop in the tax rate to 30% for the 2009 and future years and a transitional rule applies to multiply RIT by .9 to compensate for this so that tax is not overpaid. In any event a similar rule exists for companies that use the uplift method.

Calculating and paying provisional tax instalments

Once the ratio is determined, the process from thereon appears to be quite straight forward. The amount of provisional tax payable on an instalment date is simply worked out by applying the ratio to the total taxable supplies for the particular taxable period. Provisional tax will be payable along with GST on 6 instalments dates that will align to GST taxable periods. The dates will depend on a taxpayer’s balance date, but for a taxpayer with a March balance date who files on a 2-month basis, provisional tax payments would be made along with the GST payment and return on 28 June, 28 August, 28 October, 15 January, 28 February and 7 May. A new GST return (GST 103) has been designed as a consequence of aligning GST and provisional tax dates. Taxpayers who are GST registered and who pay provisional tax will start to receive this new look form in the next month or so. Apparently there are 8 versions of the GST 103 and which version you will receive will depend on balance date, GST filing frequency, whether the GST ratio method is used and whether GST returns are filed for more than one location or branch.

Opting or falling out of the regime

The GST ratio election is relevant for the current and later tax years, provided the threshold requirements for the previous year are met. While not wholly clear, it appears the Inland Revenue will need to recalculate the ratio and measure thresholds annually once it has information from assessments for the preceding year. To the extent the taxpayer is no longer eligible in the next year; the taxpayer can change calculation method to the standard method (but only if this change is made before the first provisional tax instalment) or to the estimation method if an instalment has already been made for the year. Taxpayers will be forced to discontinue using the GST method during a year if they no longer meet the eligibility thresholds as a result of a reassessment, cease to be GST registered or fail to file a GST return within 60 days after the due date for filing. Of course once out of the GST ratio method, the use of money interest regime would then kick in.

Below is a summary of key points to consider in working out whether this method is right for you.

No exposure to UOMI regime while you qualify for the method	This is a huge positive, but note that if you overpay provisional tax there is no UOMI interest received either – although perhaps the risk of overpaying is lower in any event.
Match payments to cash flowBudgeting and cash flow forecasts will be easierIt may particularly suit businesses with seasonal or fluctuating income or in fact companies in the early years of growth.	Taxpayers will be making 6 instalments instead of 3 but payments likely to be smaller payments spread out over the year and timed to match cash flow. As a result of combining the two taxes on the one GST form, taxpayers with a GST refund will be able to offset the refund against their provisional tax liability. This may be positive (or not) for some taxpayers.
The make up of taxable supplies and income	If income includes significant interest and dividends, the ratio might also not accurately reflect the tax payable given these would be excluded from taxable supplies. Likewise disposals of capital assets will be included in taxable supplies albeit in the latter case there is the option of adjusting for this on the GST return and the ratio itself. Although not being exposed to UOMI lessens any real cost here.