When announced in the Budget last year this change appeared to be about allowing contractors to choose their own withholding tax rate – within limits.
But as they say the devil is in the detail.
In a nutshell, if you are invoicing an IT services or recruitment company for your contract services then the IT services or recruitment company will be required to deduct withholding tax from all payments to you from 1 April 2017 (even for March 2017 work paid in April). And the default rate is 45%. The new change is that it now affects those contracting through companies.
If you’re a sole trader the 45% will cover more than your usual tax obligations as the top tax rate is 33% so after you claim your business expenses then you should receive a sizeable tax refund. But you’ll have to wait till year end to receive it.
Details are at http://www.ird.govt.nz/news-updates/contractor-changes.html.
To reduce the amount being deducted you can complete an IR330C form: http://www.ird.govt.nz/resources/9/c/9c019ad0-9071-4f3d-babb-7aa37e954bb4/IR330C.pdf but the minimum rate you can choose is 10%. The 10% is probably the best option but you may then have tax to pay at year end if that rate ends up being too low . You can calculate a more accurate rate using the IRD calculator at http://www.ird.govt.nz/calculators/tool-name/tools-t/tax-rate-estimation-tool-contractors.html. For example:
- If your income after expenses and excluding GST is around $80,000 then the rate should be 22%.
- If your income is around $100,000 then the rate should be 24%.
- If your income is $200,000 then the rate should be 28%.
Remember by using a 10% rate you are deferring the tax you pay, but you end up paying the correct amount of tax based on your earnings in the end.
The other option is to complete an IR23BS. This is a complicated form but will potentially allow you to set the rate that the IT services or recruitment company charges to an even lower rate, depending on your costs and tax losses from other business activities for example, if you have a rental property with large losses.
If you are a sole trader and already have a certificate of exemption from withholding tax that exemption will expire at 31 March 2018.
It all becomes far more complicated if you provide your contract services through a company. By the intermediary recruitment or IT services firm deducting withholding tax, this reduces the amount paid to your company. Effectively then because of the personal services attribution rules the income will be allocated to you at year end but the tax will already have been mostly paid by your company. Meanwhile you still need to pay PAYE during the year on your salary (or provisional tax) and the company will receive a large refund at year end.
Because this doesn’t make sense you can choose a lower withholding tax rate for the company by completing an IR23BS in the company name and setting the withholding tax rate to zero. Otherwise the IT services or recruitment company can deduct tax at 45%.
Special tax code application (IR23BS): http://www.ird.govt.nz/forms-guides/number/forms-001-99/ir023bs-form-special-taxcode.html
The only other way to reduce the compliance costs of all this extra work and to minimise the real cashflow issues is for you to contract in your own name for those jobs that go through a recruitment or IT services company and just use the company for contracts you obtain directly. And you should expect to pay higher monthly fees to your IT services or recruitment company to cover their additional compliance costs. If the recruitment agency isn’t quite ready to implement these changes, they do have up until 1 July to get their systems set up which may delay things a little for you.
Example: IT Recruitment Co Ltd has agreed to provide web designers for Client Co. IT Recruitment Co arranges for Services Provider Ltd to provide people for Client Co. IT Recruitment Co Ltd is arranging people to provide work directly to clients. As a result, they are in a labour-hire arrangement and this labour-hire arrangement is part of their labour-hire business. As a result IT Recruitment Co Ltd is required to withhold tax at 45% from any payment made to Services Provider Ltd. Services Provider Ltd may apply for a special tax code to reduce its rate of withholding (including applying for a rate of 0%).