What is a PAYG instalment?
The Pay As You Go (PAYG) instalment system requires certain taxpayers deriving business or investment income to pay instalments progressively towards their income tax liability. When the taxpayer lodges their tax return, these instalments are credited against their income tax liability and any excess amounts paid are refunded.
PAYG instalments are distinct from PAYG withholding, which refers to the tax withheld by payers from payments to payees.
The calculation of these PAYG instalments, and the number of instalments required in a year, is dependent upon a taxpayer’s circumstances. Taxpayers can vary the amount of a PAYG instalment if the total does not reflect their expected income tax liability for the year.
Who is required to pay PAYG instalments?
A taxpayer only needs to pay PAYG instalments if they have been notified by the ATO, typically through myGov, Online services for business or by mail.
The operation of the PAYG instalment system, including determining how much to pay and when, is set out under Div 45 of sch 1 to the Taxation Administration Act 1953. Taxpayers whose assessable income has only consisted of withholding payments (other than non-quotation withholding payments) are not required to pay PAYG instalments.
The Commissioner is not obliged under legislation to require a taxpayer to make PAYG instalments — the ATO effectively has discretion to determine entry thresholds for the PAYG instalment system. Taxpayers are automatically required to pay PAYG instalments if:
For an individual, they have:
- Business and investment income in their most recent tax return of $4,000 or more
- Tax payable on their latest notice of assessment of $1,000 or more, and
- Estimated tax for the current income year of $500 or more.
For a company, they either:
- Have business and investment income in their most recent tax return of $2 million or more
- Have estimated tax for the current income year of $500 or more, or
- Are the head company of a consolidated group.
A new business will not be entered into the PAYG instalment system until its first income tax return has been assessed. Taxpayers that are new to business can start voluntary PAYG instalments to help smooth out their cashflow and avoid a large tax bill in their second year of business.
How many PAYG instalments are payable?
Taxpayers may be required to make PAYG instalments on a monthly, quarterly or annual basis. The ATO will advise a taxpayer of how often they need to pay PAYG instalments at the time they are first entered into the PAYG instalment system.
Most taxpayers make PAYG instalments on a quarterly basis. Taxpayers with business income of more than $20 million are required to make monthly PAYG instalments. Individuals eligible to make quarterly PAYG instalments that carry on a primary production business or are special professionals may have the choice to pay in two instalments. Some taxpayers may also be eligible to make annual PAYG instalments if their most recent estimated tax amount notified by the Commissioner was less than $8,000. For further discussion on the rules for determining the frequency of PAYG instalments, see the Australian Master Tax Guide at ¶27-170.
Taxpayers may be eligible to change the frequency of their PAYG instalments (eg from a quarterly to annual basis). This choice is generally required to be made by the date that the first quarterly instalment for the income year would be due. For most taxpayers, this choice would be required to be made for the 2022–23 income year by 28 October 2022, being the due date for September 2022 quarterly instalments.
PAYG instalment payment options
The amount of a PAYG instalment is either:
- predetermined by the ATO (Option 1), or
- Calculated by a taxpayer by applying an instalment rate to their business and investment income (Option 2).
Companies with business and investment income over $2 million that are not small or medium business entities (aggregated turnover less than $50 million) are not eligible to pay using the predetermined instalment amount.
The predetermined instalment amount is calculated based on information in a taxpayer’s most recent tax return and adjusted to reflect likely growth in income. This adjustment is typically based on changes in Australia’s gross domestic product (GDP) over the previous 2 calendar years, but has been set at 2% for the 2022–23 income year.
The instalment rate is also calculated by the ATO based on a taxpayer’s most recent tax return. This instalment rate is a percentage calculated by dividing estimated (notional) tax by business and investment income. “Notional tax” broadly refers to estimated tax on business and investment income, adjusted for tax losses; changes in law; and other factors that may affect the calculation of the current-year tax liability.
Taxpayers that are eligible to choose between using the instalment amount or the rate will be shown both options in their activity statement or instalment notice. Once the choice is made, the option applies for the rest of the income year and cannot be changed until the first quarter of the next income year. For most taxpayers already paying quarterly PAYG instalments, the choice of options will be available in the September 2022 instalment.
Varying PAYG instalments
Taxpayers can vary their PAYG instalments if the total instalments for the year will not reflect their expected income tax liability. For taxpayers that pay a predetermined instalment amount, varying the instalment amount may be appropriate where a significant change is expected in the level of business and investment income or associated deductions.
For taxpayers that calculate their instalments by applying the instalment rate, varying the instalment rate may be appropriate where the taxable proportion of income has changed (eg where income is expected to fall, but running costs will remain the same).
There is no requirement to vary PAYG instalments from the amount or rate advised by the Commissioner, and any overpaid amounts are refunded after the relevant tax return is lodged. Underestimated PAYG instalments may result in a hefty tax bill when the relevant tax return is lodged after year end. If varied instalments are less than 85% of total tax payable, taxpayers may be liable for general interest charges on the difference.
Considerations for practitioners beyond tax
It can be tempting to give PAYG instalments little thought on the basis that “it will all come out in the wash”, particularly where it is the last step to finalising an activity statement. However, taking the time to evaluate whether the ATO’s instalment amount or rate is appropriate can help avoid the distress of an unexpectedly large instalment later in the year. It may also provide an opportunity to better understand your client’s business and investment structure or cashflow needs.
Example
A wedding planner operates as a sole trader paying PAYG instalment amounts under Option 1. His business income was significantly reduced in 2020–21 because of Covid-19. The September 2022 quarter PAYG instalment will be credited towards his 2022–23 income tax liability. As the planner has not yet lodged his 2021–22 tax return, the instalment amount will be based on 2020–21 tax return information. The ATO’s instalment amount for September 2022 is therefore unlikely to reflect the planner’s expected income tax liability for 2022–23, given the significant reduction in their business income in 2020–21.
Note that there are no penalties for tax shortfalls where a taxpayer does not vary the instalment amount or rate notified by the ATO. The individual in the scenario above is under no obligation to vary their instalments upwards. However, tax practitioners should ensure that their clients understand what their PAYG instalment amount represents and how it might affect their tax liability in the coming year.
