Payments of provisional tax by small and medium businesses will be reformed under changes announced to day by Prime Minister John Key.

A new pay-as-you-go option will be available to businesses with a turnover of less than $5 million.

"It means small business owners and managers can get on with managing their businesses rather than being tied up in tax compliance," Mr Key said.

"That's what we want and that's what businesses do want, so it's a win-win."

At present provisional a tax is paid in three instalments by estimating the likely tax bill for the whole year.

The new option drops the estimation and works out tax payment on an ongoing basis throughout the year.

Every two months, accounting software will calculate taxable income for that period.

Businesses will be prompted to make the right tax payment directly through their accounting system and generally at the same rate as gst, 15 per cent.

Use-of-money interest will not apply to taxpayers who choose the pay-as-you-go option and who pay their tax on time.

Mr Key said up to 110,000 small businesses could be eligible to use the new accounting income method and it would start from April 18 when IRD's new computer system was up and running.

In addition, taxpayers who continue to use the standard method for calculating provisional a tax - the "uplift" method - won't be subject to use-of-money interest if their tax liability for the year is under $60,000 and their tax is paid on time.

That includes companies as well as individuals and is expected to take 67,000 taxpayers out of the use-of-money interest regime.

For taxpayers with a tax liability over $60,000 who use the standard "uplift" method, use-of-money interest will apply only from the third and last instalment of provisional tax.

In another part of the SME budget package, contractors will have more flexibility to choose a withholding tax rate that suits their individual circumstances.

About 130,000 contractors have withholding tax deducted  but at varying rates: shearer so, for example at 15 per cent, freelance journalists at 25 per cent, and cleaning contractors at 20 per cent.

"You may have scratched your head at these differences. We are going to make the system more flexible."

From April 2017, it will be easier for contractors to select their own rate-  at a minimum of 10 per cent.

Contractors who aren't subject to withholding tax will be able to opt in - with the payers agreement.

Mr Key also announced that from April 1, 2017  for new debts with IRD, the 1 per cent monthly penalty will be scrapped for income tax, get, and some other payments.

That does not apply to they I mediated penalty for late payments, and the four per cent penalty after a further week.

Use-of-money interest will remain on overdue tax.

"We need to be realistic," said Mr Key.

"Building up a very large debt to Inland Revenue is often an ineffective way top get individuals and businesses to resolve their tax situation."

The Government wanted to give taxpayers more opportunity to talk to Inland Revenue to work out a way to repay their tax debts before they became too big to resolve.

Inland Revenue was releasing an issues paper today that went through the package in more detail.