Provisional tax is based on estimates, so SARS does not expect taxpayers to predict their final taxable income perfectly.
However, there is an important difference between making a reasonable estimate that later turns out to be incorrect and substantially underestimating your taxable income or paying provisional tax late.
Getting provisional tax wrong can result in penalties and interest being added to the tax you already owe.
For business owners, freelancers and other provisional taxpayers, understanding these rules is an important part of managing your tax obligations.
What Can Cause a Provisional Tax Penalty?
There are several situations that can create additional costs, including:
- Paying your provisional tax after the deadline
- Underestimating your taxable income
- Failing to properly submit your second provisional tax estimate
- Paying less provisional tax than required
- Leaving an outstanding tax liability unpaid
These situations are not necessarily treated in exactly the same way.
A late payment, for example, is different from an underestimation of taxable income.
What Is the Penalty for Paying Provisional Tax Late?
SARS imposes a 10% late-payment penalty on late provisional tax payments relating to the first and second provisional periods.
For example, suppose your second provisional tax payment should have been:
R40,000
If that amount is paid late, a 10% late-payment penalty could mean an additional:
R4,000
That is before considering any applicable interest.
A missed deadline can therefore become expensive very quickly.
This is why it is important to treat the submission of your IRP6 and the actual payment of the provisional tax as two separate things that both require attention.
Submitting the return does not help if the required payment is forgotten.
SARS Can Also Charge Interest
Penalties are not necessarily the only additional cost.
SARS may also charge interest on late or underpaid tax at the prescribed rate.
The prescribed interest rate can change over time, which means taxpayers should not assume that a rate they encountered in a previous tax year still applies.
The practical lesson is simple:
The longer an outstanding tax amount remains unpaid, the more expensive the problem can potentially become.
If you discover that provisional tax should have been paid and was not, it is generally better to address the situation promptly rather than waiting until your annual income tax return is assessed.
What Is an Underestimation Penalty?
Underestimation penalties relate particularly to the second provisional tax estimate.
Remember that provisional tax is based on your estimated taxable income for the full year.
By the second provisional period, which is at the end of the tax year for a February year-end taxpayer, you should have a reasonably good idea of your actual financial position.
SARS therefore applies rules designed to discourage taxpayers from deliberately or unreasonably submitting estimates that are too low.
The calculation differs depending on whether your actual taxable income is R1 million or less, or exceeds R1 million.
If Your Actual Taxable Income Is R1 Million or Less
For provisional taxpayers whose actual taxable income is R1 million or less, SARS applies a test involving both:
- 90% of actual taxable income, and
- The taxpayer’s basic amount
Broadly, an underestimation penalty may arise where the second estimate is less than 90% of the actual taxable income and also less than the basic amount.
The calculation itself is more technical than simply taking 20% of the difference between your estimated income and your actual income.
This is important because statements such as:
“You must always estimate at least 90% of your income.”
are an oversimplification of the actual provisional tax rules.
Your basic amount can also play an important role.
What Is the Basic Amount?
The basic amount is generally derived from the taxable income reflected in a previous assessment, subject to the rules governing how that amount is determined and adjusted.
It effectively provides a historical reference point that can be relevant when preparing a provisional tax estimate.
However, relying blindly on the basic amount is not always appropriate.
Imagine your previous taxable income was R500,000 but your business has grown considerably and you now reasonably expect taxable income of R900,000.
Simply using the older figure without considering what has actually happened during the current year could result in an inadequate provisional tax estimate.
Your current financial position still needs to be considered.
What If Your Taxable Income Is More Than R1 Million?
The rules become particularly important once actual taxable income exceeds R1 million.
For taxpayers in this category, the second provisional tax estimate generally needs to reach at least 80% of the actual taxable income to avoid the relevant underestimation penalty calculation.
This means that taxpayers expecting higher taxable income need to pay particularly close attention to their February estimate.
Consider a business that expects taxable income of approximately R1.5 million.
Submitting an estimate of R700,000 simply because cash flow is tight is not a legitimate cash-flow strategy.
It could create a substantial provisional tax shortfall and expose the taxpayer to penalties and interest.
How Much Is the Underestimation Penalty?
Where the applicable requirements are met, SARS’s provisional tax rules provide for a penalty calculated at 20% of the relevant tax shortfall determined under the prescribed formula.
It is important to understand that this does not simply mean:
Actual income minus estimated income × 20%.
The penalty calculation works with the tax payable on the relevant taxable-income amounts and takes account of items such as provisional tax and employees’ tax already paid.
This is why an underestimation penalty should ideally be calculated properly rather than estimated informally.
What If My Income Changed Unexpectedly?
An inaccurate estimate does not necessarily mean that you deliberately did something wrong.
Businesses operate in the real world.
A company could unexpectedly:
- Win a major contract
- Lose a major customer
- Experience unusually strong December or January sales
- Receive an unexpected payment
- Sell an asset
- Experience a large capital gain
- Incur an unexpected expense
- Have a customer settle a large outstanding account
- Experience a sudden downturn
Your provisional tax estimate should be based on the information reasonably available when you prepare it.
This is also why bookkeeping becomes particularly important before the second provisional tax deadline.
The better your financial information, the better your estimate can be.
Don’t Deliberately Lower Your Estimate to Help Cash Flow
One of the most dangerous approaches is treating the provisional tax estimate as an amount that can simply be adjusted downward because the business does not currently have enough cash to pay SARS.
Taxable income and cash in the bank are not the same thing.
A business can be profitable for tax purposes while experiencing cash-flow pressure.
If the estimated taxable income is artificially reduced purely to make the provisional payment more affordable, the taxpayer may simply be moving the problem into the future while potentially adding penalties and interest.
Cash-flow difficulties should therefore be dealt with as a cash-flow problem, rather than by submitting an estimate that cannot reasonably be supported.
Keep Evidence Supporting Your Estimate
A provisional tax estimate should ideally be supported by your accounting information.
Depending on your circumstances, this could include:
- Management accounts
- Year-to-date income
- Business expenses
- Bank records
- Debtors and creditors
- Rental income
- Investment income
- Payroll information
- Expected invoices
- Capital gains
- Forecast income and expenditure
You should be able to explain how the estimate was reached.
This is particularly useful if your final taxable income turns out to be materially different from what you expected.
What If I Realise My Estimate Was Wrong?
Discovering a problem does not mean you should wait for SARS to identify it.
Depending on when the error is discovered, there may still be opportunities to address the tax shortfall.
For example, a taxpayer may consider whether an additional third provisional tax payment should be made after year-end.
This voluntary top-up payment can be useful where the final tax position becomes clearer after the second provisional period.
However, a third payment should not be regarded as a way of automatically cancelling an underestimation problem created at the second provisional period.
We cover the purpose of this payment separately in “The Third (Optional) Provisional Payment: When and Why You Should Use It.”
Can SARS Remit a Provisional Tax Penalty?
In certain circumstances, SARS may consider remission of a penalty.
This does not mean that every penalty can simply be removed on request.
The circumstances, taxpayer behaviour and type of penalty matter.
For example, SARS’s guidance provides for circumstances in which an underestimation penalty may potentially be remitted where the taxpayer did not deliberately or negligently underestimate taxable income.
If you believe a penalty has been incorrectly imposed or there are legitimate grounds for remission, the matter should be assessed properly and the appropriate SARS process followed.
Prevention Is Better Than Trying to Fix the Penalty
The easiest provisional tax penalty to deal with is the one you avoid.
Before each provisional tax deadline:
Keep your accounting records current.
Review your year-to-date financial results.
Consider all sources of taxable income.
Estimate the remainder of the year realistically.
Submit the IRP6 on time.
Make sure the payment actually reaches SARS by the deadline.
The second provisional tax calculation deserves particular attention because this is where underestimation penalties become especially relevant.
Need Help With Your Provisional Tax Calculation?
Provisional tax becomes more complicated when income changes during the year, a business grows rapidly or several different income streams need to be taken into account.
Boatwright Consulting can assist with reviewing your taxable income, preparing your provisional tax calculation, submitting your IRP6 and identifying potential underpayment or penalty risks before they become larger problems.
Contact Boatwright Consulting if you are concerned that your provisional tax estimate may be too low, you have missed a payment deadline, or SARS has already imposed a provisional tax penalty.
This article provides general information and should not be regarded as tax advice specific to your individual circumstances.