If you are a business owner or earn investment income, regular PAYG instalments can help you manage your tax liabilities.
So, what is a PAYG instalment, how does it work and how does it differ from PAYG withholding? The article below will explain it all.
What Is a PAYG Instalment?
Pay-as-you-go (PAYG) instalments are regular payments made towards a projected tax bill. The system typically applies to those who earn income from their business or investments, such as superannuation, shares or property,i.e. any income outside of their salary.
By making PAYG instalments, you are fulfilling your tax obligations in advance with smaller payments throughout the year instead of paying a large sum when you lodge your annual tax return.
Note: Even though you pay PAYG instalments, you still need to lodge an annual tax return.
How Does PAYG Work?
How much you owe in tax is calculated at the end of the financial year when your annual tax return is assessed.
The PAYG instalments you paid throughout the year are then credited against the assessment to figure out if you need to pay more tax or are owed a refund. Put simply, if you underpay on your PAYG instalments, you will have to cover the remaining amount. Conversely, if you overpay on the instalments, you will get a tax credit and receive a refund.
Most businesses and individuals pay quarterly instalments (usually 28 days after the end of the quarter), although you might be eligible to pay once or twice a year. Companies that make more than $20 million in instalment income, though, need to lodge and pay PAYG instalments every month. The ATO will inform you of the payment frequency.
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Do I need to pay PAYG Instalments?
When an individual’s investment or business income reaches a certain amount, you will need to start paying your tax in PAYG instalments.
You will automatically enter the PAYG system if you are an individual, trust or sole trader who
- Has an instalment income of $4,000 or over on the latest tax return,
- Needs to pay $1,000 or more in tax (as per your notice of assessment), or
- Has an estimated (notional) tax of at least $500.
A company or super fund will also automatically enter if:
- It has instalment income on its latest tax return of at least $2 million,
- Has an estimated (notional) tax of $500 or over, or
- It is the head company of a consolidated group.
- Related reading:
- How to start investing in Australia
- How to start a home business?
You can also choose to make voluntary instalments to the PAYG system as a sole trader or individual in order to manage your cash flow and avoid a huge tax bill at the end of the year.
How to start making PAYG payments?
If you are automatically entered into the system, the ATO will inform you when payments are due so you can start paying instalments.
If you are making voluntary PAYG instalments you need to
1. Estimate the amount of tax you need to pay: You can do this by calculating your annual income (apart from salary) and tax deductions or you could consult your accountant to get an accurate estimation;
2. Calculate how much you will need to pay in instalments: You can calculate this yourself or use the ATO’s PAYG instalments calculator. You may then determine how often you want to pay.
3. Request to enter the PAYG instalments system: Go to the myGov portal and Select Tax⇒Manage⇒PAYG instalments.
4. Start paying: Just as with those automatically entered in the system, you will get an activity statement or instalment notice informing you when your instalments are due and what your PAYG instalment rate is.
How are PAYG instalments calculated?
When making PAYG payments you can either allow the ATO to calculate the amount for you or you can do it yourself (this is advisable if your business or investment income changes often).
How is the ATO PAYG instalment calculated?
The PAYG instalment is calculated based on your latest lodged tax return plus an uplift factor, also known as the GDP adjustment factor.
Since the ATO uses the latest available information to calculate the amount, there will be a change in your PAYG Instalments every time you lodge your tax return. This also means that the sooner you lodge your annual tax return, the more accurate your PAYG payments will be for the rest of the year.
Calculating the instalment amount yourself
If you go with the second option you need to multiply your PAYG instalment rate by your income (business or investment). The instalment rates, on the other hand, are determined by dividing the estimated notional tax by the instalment income and multiplying it by 100.
With this option, you can ensure that your PAYG instalments are as close as possible to your estimated tax liability rather than a projection based on your last tax return.
Which option should you choose?
It’s important to note that not everyone is eligible to choose between these two options—in most cases, the ATO will calculate the amount for you.
The decision between the two options needs to be made before you start making payments and will apply for the rest of the tax year. Whatever option you choose (or are allowed to choose) it will not change the amount of income tax you need to pay.
Plus, you can vary the amount you pay in both instances to adjust it to your income. Just be aware that if you vary PAYG instalments downwards (let’s say down to zero) and you need to pay 15% or more in tax at the end of the year, you may be required to pay interest as well.
On the other hand, there are no penalties for tax shortfalls if the taxpayer has not varied the PAYG instalment amount or rate. This is why the ATO advises against varying instalments and recommends to continue paying what you pay and then have the tax refunded at the end of the year.
What Is the Difference Between PAYG Withholding and PAYG Instalment?
With PAYG withholding, business owners withdraw a certain amount of their employee’s paycheck and pay it to the ATO so that workers won’t have a huge tax bill at the end of the financial year. Employees can then claim against the amount withheld, just as they would with PAYG instalments.
Employers can withhold PAYG amounts for payments to workers, contractors (that you enter into voluntary agreements with) and businesses that haven’t provided their ABN.
There are a few things to keep in mind with PAYG withholding, meaning you need to:
- Register for PAYG withholding before you start withdrawing amounts
- If you close down your business or have no employees anymore, you should cancel your PAYG withholding registration
- Only withholds payments of workers who are legally allowed to work in the country
- Keep all relevant records
Note that when a company fails to meet PAYG withholding obligations, the director will be held personally accountable and will be required to pay the amount that should have been withheld.
FAQs
1. What is your PAYG instalment income?
Your PAYG instalment income is the gross business and investment income without GST. The income you include can be anything from rent, dividends, foreign income, interest earned on investments, gross sales, fuel tax credits and money you earned from the sale or supply of goods and services. Luxury car tax, GST, salary or wages, franking credits and grants are typically not included in your instalment income.
2. Can you stop making payments?
Yes, the ATO will automatically remove you from the system if you are an individual, trust, company or super fund and you have
- Estimated (notional) tax liability of $500 or less
- Instalment income of $4,000 or less or instalment income (not including capital gains) of less than $2 million for super funds and companies
- Tax debt of $1,000 or less
- Calculated PAYG instalment rate of 0.0%
Those claiming Senior and Pensioners tax offset or individuals under 18 that have lower income than the marginal threshold will also be automatically excluded from the PAYG instalment scheme.
3. What is a PAYG instalment notice?
You might get an instalment notice instead of a business activity statement (BAS) if you report and pay PAYG instalments every quarter, allow the ATO to calculate your instalment amount and have no other reporting requirements.
