If you’re an independent contractor, you’ve definitely heard the term “Withholding Tax” before. But you may not be fully across how it all works.
Withholding taxes are designed to help you pay your income tax bill throughout the financial year, instead of right at the end. The reason it can get complicated for contractors and freelancers is because their earnings are variable, meaning it’s hard to pick a flat rate that accurately applies to fluctuating income.
On top of all this, the term withholding tax (not a proper noun) is different from Withholding Tax (proper noun). If you have savings accounts or investments, you’ll also need to be across Resident Withholding Tax (or Non-Resident Withholding Tax, depending on your tax status). You know you can choose your own tax rate, but what rate should you choose? How do you avoid overpaying or underpaying your taxes?
Great questions. We’ve got answers. Let’s get started!
- What is withholding tax?
- Types of withholding tax
- Withholding Tax
- Resident Withholding Tax
- Non-Resident Withholding Tax
- Tax on PIE income
- Withholding tax and Hnry
What is Withholding Tax?
Technically, withholding tax is any tax that’s “withheld at source”. Basically, if whoever is paying you puts some of your pay aside as income tax to pass on to the IRD on your behalf, that’s withholding tax.
By this definition, Pay As You Earn (PAYE) tax is a kind of withholding tax, in that it’s deducted from your pay before the rest hits your bank account. But generally, PAYE isn’t what we mean when we talk about withholding tax.
Instead, think Withholding Tax (proper noun). Withholding Tax is tax specifically deducted from schedular payments, at a nominated flat tax rate (don’t worry, we’ll break this down in a sec).
On top of this, you’ve also got Resident Withholding Tax – tax withheld by a bank or fund manager on interest or dividends, and Non-Resident Withholding Tax – which is the same thing, but for non-residents, and levied at different rates depending on international tax agreements.
Confused? Yeah, we can see why. Let’s break it down.
Types of withholding tax
Withholding Tax (WT)
If you’re a contractor or freelancer receiving schedular payments, this is the Withholding Tax you know and love (or at the very least, like. Tolerate? Let’s keep workshopping).
Withholding Tax (mind the capitals) is tax deducted from schedular payments. Schedular payments are payments made to independent contractors and freelancers for their work in certain industries, as set out by Schedule 4 of the Income Tax Act 2007. It’s riveting stuff.
Basically, to make sure that contractors were paying some form of income tax throughout the financial year, the government of the time decided to implement a Withholding Tax system. Income tax would be deducted from contractor pay at a flat rate, depending on the industry, to help cover their final tax bill.
While this was a good system in theory, it was a bit iffy in practice – unlike our income tax system with progressive bands and rates, it’s difficult for a flat tax rate to accurately calculate income tax owed.
Then, in 2017, the government decided to shake things up by allowing contractors to pick their own WT rate – so long as it was above the minimum 10% for residents, and 15% for non-residents. This meant that contractors could choose a WT rate that was closer to their effective tax rate, so they didn’t wildly overpay or underpay their income tax.
All you have to do is nominate your tax rate in every IR330c you provide to recruiters, clients, and companies they work for.
This system, while better, still isn’t perfect. Unless you know what you earn in a financial year down to the last dollar, getting your WT tax rate spot on is a serious feat of calculation. That is, of course, unless you use Hnry.
We may be biased, but we reckon using Hnry is the best way to get your taxes right every time. Let us know the Withholding Tax rate you’re using with each of your clients, and we’ll calculate and deduct any extra income tax you may owe.
Plus, we also sort your ACC levies, GST, student loan repayments and KiwiSaver contributions (optional) – which Withholding Tax doesn’t cover.
So what are you waiting for?
Resident Withholding Tax (RWT)
Resident Withholding Tax is tax withheld on income from interest and dividends, if you’re a tax resident. If you’re not a resident for tax purposes, you’re subject to Non-Resident Withholding Tax on this income.
(When it comes to naming conventions, the IRD are definitely substance over style.)
Typically, RWT is withheld by the financial institution you’re investing with, like your bank, fund manager, or investing platform. Like with Withholding Tax, they forward RWT to the IRD on your behalf.
The amount of RWT withheld can vary depending on your tax status, the type of interest or dividends you earn, and the information you provide your bank/fund manager. For example:
- You can choose your RWT rate for interest earned on savings accounts and term deposits. If you don’t choose a rate, the default is 33%.
- Dividends and unit trust distributions are all taxed at a rate of 33%
- If you don’t give your payor your IRD number, they’re required to withhold tax at a rate of 45%
Non-Resident Withholding Tax (NRWT)
If you’re not a resident of Aotearoa, eg. a foreign investor, income from interest and dividends will be taxed at a Non-Resident Withholding Tax rate.
Generally, NRWT rates are:
- Interest – 15%
- Royalties – 15%
- Dividends – 30%
However, if you’re a resident of a country that has a double tax agreement with, these rates are reduced.
📖 You can find a list of these countries and relevant NRWT rates on the IRD website.
Tax on portfolio investment entities (PIEs)
Income earned through PIEs is taxed slightly differently, because it’s not linked to income tax rates at all. Instead, they have their own set of progressive tax rates, capped at 28%.
PIE income is therefore taxed at a Prescribed Investor Rate, or PIR. Because tax on PIE income is considered a final tax, you don’t need to declare PIE income in your tax return (unless you use the wrong PIR rate).
Finding your PIR is slightly complicated – luckily, the IRD has a tool you can use to figure it out.
Hnry makes it easy
With Hnry, you tell us what Withholding Tax rate you’re using for your schedular payments, and we do the rest!
Hnry is an award-winning tax app and service. For just 1% +GST of your self-employed income, capped at $1500 +GST a year, Hnry will calculate and pay all your taxes, levies and whatnot for you, including:
We also file your income tax and GST returns for you – it’s all part of the service.
Basically, we make earning self-employed income easy by taking care of all your tax admin. Join Hnry today, and you’ll never have to think about tax again.
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