By Tim Kirkpatrick, Co-CEO at Tax Traders
Inland Revenue (IR) has recently decreased its use-of-money interest rates – and Tax Traders expects there will be another drop in May, based on current interest market trends.
Following recent official cash rate (OCR) cuts by the Reserve Bank of New Zealand (RBNZ), discussing interest rate movements has been a national pastime. But these changes also have implications for the interest IR charges a taxpayer for the late payment of tax and the interest IR pays a taxpayer for the overpayment of tax.
As of 16 January, the new IR underpayment rate is 10.88% (down 0.03% from 10.91%). The new IR overpayment rate is 4.30% (down 0.37% from 4.67%).
This marks the first IR rates adjustment since 29 August 2023.
The recent movements in IR's interest rates are relatively minor when compared to recent cuts in the OCR.
There's a reason for that: IR follows a specific method for reassessing interest rates, and the current rates are based on the interest rate environment from August 2024.
Inland Revenue’s methodology utilises the interest rates in effect at the end of the month of the last standard provisional tax date as the source for new rates. The standard provisional tax dates are 28 August, 15 January and 7 May.
This means only the first OCR cut of 0.25%, delivered on 14 August by the RBNZ, is included in these new IR rates, as the new rates for January are based on the interest rate environment from 31 August.
Therefore, the additional 1.00% of cuts delivered by the RBNZ across October and November 2024 have not yet been factored into these new IR rates.
The method for setting the IR interest rates is outlined in the Taxation (Use of Money Interest Rates Setting Process) Regulations 1997.
IR’s underpayment rate is based on the RBNZ’s floating first mortgage rate for new customers, plus 2.50% (expressed as 250 basis points in the Regulations).
The overpayment rate is based on the RBNZ’s 90-day bank bill rate minus 1.00% (or a rate of 0% if this calculation would be negative).
IR interest rates are reviewed regularly and adjusted as required to ensure they are in line with market interest rates.
When reviewing its interest rates, IR will use RBNZ market interest rate data taken from the end of the month of the preceding standard provisional tax date.
So, for this recent rate change, IR would have used the floating first mortgage rate for new customers and the 90-day bank bill rate as of 31 August 2024 as the basis to calculate its underpayment and overpayment rates. At this time, the RBNZ's floating first mortgage rate for new customers was 8.38% and the 90-day bank bill rate 5.30%.
Add 2.50% to 8.38% and you get the new IR underpayment rate of 10.88%. Subtract 1.00% from 5.30% and you get the new IR overpayment rate of 4.30%.
IR will propose an adjustment to its interest rates when one of the following occurs:
A. Either of the RBNZ’s 90-day bank bill rate or the floating first mortgage new customer rate moves by 1.00% or more from the figures used to calculate the previous rate change.
B. Either of the 90-day bank bill rate or the floating first mortgage new customer rate moves by 0.20% or more, and IR’s rates haven’t been adjusted in the last 12 months.
This approach means that where rates change significantly (greater than 1.00%), IR will move to quickly to reset rates at the next standard provisional date. This is why we saw a quick succession of four increases to the IR rates across August 2022 to August 2023.
Where interest rates are moving, but at a much slower rate, IR rates are reset around once per year. And if there has been less than a 0.20% movement in interest rates across a 12-month period, there will be no change in the IR interest rates.
Section 120H, subsection (1)(b) of the Tax Administration Act 1994 allows for IR interest rates to be set and adjusted by Order in Council. These Orders are made by the Governor-General on recommendation of the Executive Council. Apart from Acts of Parliament, Orders in Council are the main method by which the government implements decisions that need legal force.
When an Order in Council is made to change the rates, the adjusted rates take effect after the next standard provisional tax payment date. Rates remain in place until changed by a subsequent Order in Council.
Compared to interest rates at the end of August, the 90-day bank bill rate has already moved by more than 1.00% (which triggers part A of the test above for resetting IR interest rates). As of 15 January, the 90-day bank bill rate was 4.11% (compared to 5.30% on 31 August).
That’s why Tax Traders expects there will be a further change in IR’s interest rates on 8 May 2025 when rates are reviewed again at the end of this month.
The floating first mortgage new customer rate for January was not available on RBNZ's website at the time of writing this article. However, if we use the end of December rate (7.39%), we can roughly calculate a forward view for IR's underpayment rate.
Based on that, we believe the IR underpayment rate from 8 May 2025 could be around 9.89% (down a further 0.99% from the rate that has taken effect in January). And using the 90-day bank bill rate as of 15 January, the overpayment rate could likely be around 3.11% (down a further 1.19%).
We will know for certain once the January data is released by RBNZ early next month. But one thing is for sure: Expect IR to cut its interest rates again on 8 May 2025.
Tim Kirkpatrick is the Co-CEO of Tax Traders, the most preferred* tax pooling provider in New Zealand.
The information in this article is Tax Traders’ general view, intended to provide enough information to inform you about this topic generally as at the date of the article, rather than comprehensive information for all situations. This article should not be relied upon to make decisions. Tax Traders recommends you seek professional advice as appropriate for your circumstances.
*Based on an independent national survey of accountants who use tax pooling.