Poor taxpayer. With the hangover of holiday overspending fresh in his memory, back-to-school expenses still haunting him and all the while dreading Day Zero, the last thing he needs is another hole in his pocket. But the country’s wallet needs to be padded and come 28 February all provisional taxpayers (except companies with a financial year ending on another date) are expected to make the second payment of provisional tax for the 2018 year of assessment.
Going back to basics, provisional tax is an advance payment of a taxpayer’s liability for normal tax. The first payment is due six months after the start of the tax year and the second on the last day of the year. It is possible to make a third or “top-up” payment within six or seven months after the end of the tax year (depending on the type of taxpayer) but, as will be explained later, a third payment does not safeguard a taxpayer from the imposition of penalties.
Who carries the honorary title of provisional taxpayer? Firstly, every taxpayer who has been issued with an IRP6 provisional tax return. Secondly, even if no return has been issued, the Income Tax Act includes the following in the definition of “provisional taxpayer”:
- Any person (other than a company) who derives income that does not constitute remuneration, an allowance or advance (for example travel and subsistence allowances). In this context, “income” is not restricted to income from a trade, but would also include investment income like interest;
- Any company; and
- Any person who is notified by SARS that he is a provisional taxpayer.
What is required of a provisional taxpayer? To supply SARS with an estimate of his taxable income for the 2018 tax year, and to make a payment of the tax calculated on this estimated income on or before 28 February 2018. The provisional tax will eventually be set-off against the taxpayer’s “real” liability for income tax once his assessment for 2018 is issued (by the end of January 2019 at the latest). If a taxpayer earns employment income in addition to his other income, any employees’ tax withheld must be deducted to calculate his liability for provisional tax. End of February being the second provisional tax period, the amount of the first provisional payment made at the end of August 2017, must also be taken into account.
There are a number of reasons for a taxpayer to put as much effort as possible into estimating his taxable income. A spot-on estimate means that he will have to pay either very little or nothing when his assessment is issued. It also means that he will not be liable for a penalty on the underestimation of his taxable income for purposes of provisional tax.
Of course, any person would be less than enthusiastic to make a payment now in respect of a debt that, strictly speaking, only becomes due almost a year onwards. The temptation is great to skim a little off the provisional payment or to make the payment a bit later when cash flow is better. Not a good idea. Since time immemorial Treasury has favoured the stick over the carrot, and the “incentives” to encourage taxpayers to make full, timeous and accurate provisional tax payments are no exception.
Penalty for underpayment of provisional tax as a result of underestimation
SARS expects the estimated taxable income on which the provisional tax is paid, to be as close as possible to the actual taxable income for the year.
This exercise is a bit easier for taxpayers who earn less. While all taxpayers are expected to make a serious calculation of their estimated taxable income, those with an income of R1 million or less can afford to be a little less accurate because they have a safety net in the form of the magical “basic amount”. For these taxpayers, the threat of a penalty only becomes a reality when their estimated taxable income is less than 90 percent of their actual taxable income and less than their basic amount. In other words, even if the estimate is off by a long shot there can be no penalty as long as the estimated taxable income is not less than the basic amount. That being said, certain other unpleasant consequences may arise where a taxpayer merely relies on the basic amount without seriously considering his actual income for the year in question.
“Basic amount” is broadly defined as the taxable income for the latest preceding year of assessment. Technically this means the latest assessment issued not less than 14 days before the date on which the estimate (IRP6) is submitted. If an estimate is made more than 18 months after the assessment for the latest preceding year of assessment was issued, the basic amount will be increased by 8 percent per year. For example, a taxpayer has fallen a bit behind in submitting his income tax returns. His 2015 return was submitted and assessed on 1 April 2016. His taxable income for 2015 will be increased by 8 percent to reach 2016, and again by 8 percent to reach 2017 for purposes of calculating his basic amount. Had he been up to date with his returns, the taxable income for 2017 would simply have been used as his basic amount.
A taxpayer whose taxable income exceeds R1 million has no basic amount to rely on. To make up for the fact that taxpayers in this class have no fall-back position, SARS will not impose a penalty unless the estimate is less than 80 percent of the actual taxable income. A special note of caution is required for taxpayers hovering near the R1 million mark. Rather do a serious (read as accurate as possible) calculation than rely on the basic amount. SARS is not concerned with whether the taxpayer reasonably expected his taxable income to exceed R1 million. Once the taxpayer has crossed the threshold, the basic amount becomes obsolete.
In the case of taxpayers with a taxable income of R1 million or less, the penalty is calculated as 20 percent of the difference between:
- The lesser of normal tax (after rebates) payable in respect of 90 percent of the actual taxable income for the year, and the tax payable on the basic amount; and
- The amount of provisional tax paid and employees’ tax withheld in respect of the taxpayer.
For example: Peter has an actual taxable income of R500 000. He submitted an IRP6 return with an estimated taxable income of R420 000. His basic amount (previous year’s taxable income) is R400 000. Although the provisional tax paid is less than 90 percent of R500 000, it is still more than his basic amount and therefore he will not be liable for the penalty. However, if he had estimated his taxable income at only R350 000, the outcome would be very different. Assume an effective tax rate of 25 percent. His basic amount will be used, as it is less than 90 percent of his actual income. Tax on R400 000 is R100 000, while he only paid provisional tax of R87 500 (calculated on the R350 000). He will be liable for a penalty of 20 percent of the difference between the tax on the basic amount (R100 000) and the provisional tax paid (R87 500). So, Peter will have to pay an underestimation penalty of R2 500.
Taxpayers with a taxable income of more than R1 million do not have the luxury of relying on the basic amount, but they are given a bit more leeway in calculating their estimated taxable income. As long as the estimate is not less than 80 percent of the actual taxable income, the taxpayer will not be liable for a penalty. If the estimate does not reach the 80 percent mark, the penalty will simply be calculated at 20 percent of the difference between the normal tax payable on 80 percent of actual taxable income and the amount of provisional tax and employees’ tax paid at the end of the year of assessment.
All is not lost for the taxpayer who has incurred a penalty. The Commissioner has the discretion to remit the penalty or part thereof. However, the taxpayer will need to satisfy SARS that the estimated taxable income was “seriously calculated with due regard to the factors having a bearing thereon and was not deliberately or negligently understated”. In practice, this is easier said than done. SARS’ view is explained as follows in their Interpretation Note 1 – Provisional Tax Estimates:
A taxpayer must therefore have sensibly (and by careful reasoning and judgment, in a mathematical manner, and using experience, common sense and all available information) determined the amount of the estimate before the Commissioner is able to reduce a penalty.
Although the Commissioner’s decision not to remit the penalty is subject to objection and appeal, it ends up being a costly and frustrating exercise for the taxpayer involved. It is in the best interest of all taxpayers to calculate their estimated taxable income as accurately as possible to prevent the imposition of the penalty in the first instance.
It must be emphasised that a third (top-up) provisional payment made at the end of September will not absolve a taxpayer from liability for the penalty at all. On the contrary, the fact that he settled his liability for provisional tax by making a third payment may even be viewed as an aggravating factor when SARS considers a request for remission. Should a taxpayer realise that he underestimated his taxable income, it may be advisable to submit an amended IRP6 return in order to avoid the imposition of the penalty. However, as explained below, a payment after the due date will render the taxpayer liable for penalties of another kind.
Penalty for the late payment of provisional tax
A penalty of 10 percent is imposed on the late payment of provisional tax. The penalty is also imposed if a taxpayer submits an IRP6 return without making payment.
To use Peter as example again: He is liable for a provisional tax payment of R100 000 on his estimated taxable income of R400 000. Should he make this payment on the 1st of March, instead of 28 February, he will be liable for a penalty of R10 000.
A taxpayer waiting until the last minute to make his provisional tax payment is tempting fate. Bear in mind that even if a payment instruction is authorised on or before the due date, the processing of the payment may take up to two days.
SARS may remit the penalty if there are reasonable grounds for the late payment, the payment has in fact been made and it is either a first incidence of non-compliance, or if the penalty is less than R2 000. In all other cases the taxpayer will have to prove “exceptional circumstances”, and when SARS says “exceptional” they really mean it. The Interpretation Note includes the following examples of circumstances under which SARS is willing to remit the penalty: natural or human-made disaster, civil unrest, serious illness or accident.
Failure to submit the IRP6 return
A taxpayer who does not submit his provisional tax return or who submits it after the due date, is deemed to have submitted a nil return. This will naturally trigger a penalty for underpayment of provisional tax as a result of underestimation – with devastating consequences for the taxpayer.
Should our Peter neglect to submit his return, his penalty will simply be calculated as 20 percent of the difference between the tax calculated on his basic amount (R100 000) and nil. He will therefore have to pay an amount of R20 000 in addition to his liability for normal tax.
Interest on late payment of provisional tax
In addition to the penalty for late payment, a taxpayer is also liable for interest at the prescribed rate (currently 10.25%).
Interest on underpayment of provisional tax
But wait, there’s more. Assume that poor Peter used his basic amount to calculate his liability for provisional tax. By doing so, he escaped the penalty for underpayment due to underestimation. He also ensured that the payment was processed by SARS before the due date of 28 February, so he is not liable for penalties or interest on late payment either. However, the provisional tax that he paid still falls short of his ultimate liability for income tax by R5 000. SARS will have none of this.
Peter now becomes liable for interest on the underpayment of provisional tax. No more estimates or basic amounts, interest is simply charged on the difference between the tax payable as per his assessment and the provisional tax paid by him. The interest is calculated from the day after the due date for a third provisional payment; in Peter’s case from the 1st of October, to the date of the assessment. If in addition he chose to submit his income tax return as late as possible, he will be liable for four months’ interest on the underpayment of R5 000.
It is in these circumstances that a taxpayer can make use of the third provisional payment to top up whatever was paid at the end of February in order to come as close to his ultimate tax liability as possible and avoid the incurral of interest.
When too much is not good enough
In 2017, the Tax Ombud’s 80 page report on SARS’ dirty tricks when it comes to the delayed payment of refunds made it clear that it does not really pay to make an overpayment of provisional tax. A taxpayer may have to wait for months for a refund, all the while suffering the frustration of submitting the one supporting document after the other to satisfy SARS that his tax return was an honest declaration of income and expenses.
In addition, another scare tactic by SARS has reared its ugly head. Some taxpayers eligible for a refund have received letters requiring them to motivate why they paid too much provisional tax. Failure by the taxpayer to convince SARS that he was just being cautious, results in the issuing of an additional assessment to increase actual taxable income to match the (over-estimated) provisional payment.
SARS’ reasoning is very simple: If the estimate is too low, the taxpayer’s provisional tax calculation is wrong. If the estimate is too high, the provisional tax calculation is accurate and the actual income understated.
Taxpayers cannot underestimate (pun intended) the importance of seriously calculating their estimated taxable income at the end of a tax year and making the necessary payment on time. The price for failing to do so is simply too high.
In the same breath, aiming too high can create its own set of problems. Especially for taxpayers who expect their taxable income to increase R1 million, the advice is to ensure that the relevant records and information used for the estimate as up to date and accurate as possible and to keep punching those calculators.
Specialist Tax Consultant