The ins and outs of PAYG instalments have a lot of Aussie business owners confused. Why? Because as business circumstances change, PAYG instalments can change right along with them. In this article, we’ll look at what PAYG instalments are and how you can anticipate how they’ll be affected depending on how your business is going and how the structure of your income evolves. First, let’s give some background.

Most Australian taxpayers are employees rather than business owners. Each time they’re paid their employer withholds an amount of tax (as calculated by their payroll software) and:

  1. Pays the net amount to the employee
  2. Pays the tax amount to the ATO, on behalf of the employee.

This system means that the ATO receives the tax of that employee throughout the course of the year. The ATO isn’t waiting until the end of the year to be paid one big lump sum from the employee and therefore it mitigates the risk that the money won’t be there when the time comes.

The ATO aims to replicate something similar for business owners (and investment income earners). This is achieved via Pay-As-You-Go (‘PAYG’) instalments. PAYG instalments effectively mean that you prepay part of your tax during the course of the year.

So, let’s now address the key points and big questions about PAYG instalments for business owners.

Key points about PAYG instalments

  • With PAYG instalments, you are paying tax during the course of the year, rather than waiting until the end of the year.
  • At the end of the year, your income is calculated. If you’ve paid enough tax already, great – there’s nothing more to pay. In fact, you might have overpaid. In this case you’ll receive a refund. If you haven‘t yet paid enough tax, you’ll have an additional amount to cover.
  • The ATO issues PAYG instalment notices quarterly: Jan-March, April-June, July-Sept and Oct-Dec. As such, the payment dates are generally in April, July, October and February.
  • If your business is registered for GST, then you’ll pay PAYG instalments as part of your BAS. Otherwise, it will be a standalone payment.
  • The amount of the instalment is calculated by the ATO using your last tax return as a guide.

1.   When does the ATO issue PAYG instalments?

The ATO will begin issuing PAYG instalment notices once they become aware that an individual or business is earning more than $4,000 of any of the below-listed income. The ATO generally becomes aware of this once they receive the first tax return that contains that income.

Sources of income that trigger PAYG instalment notices:

  • Business profit
  • Rental property income
  • Dividends/distributions
  • Interest income
  • Royalties

2.   How does the ATO calculate PAYG instalments and why do they fluctuate?

In making its calculation, the ATO will review your last tax return and determine how much income you’ve earned that warrants PAYG instalments. They will then calculate how much tax arose from this income. This now becomes a baseline for your instalments for the following year (with a minor adjustment for inflation). The ATO essentially wants you to pay that estimated tax evenly over the four quarterly instalments. However, adjustments to PAYG instalments can occur suddenly – especially for a growing business. Beware the catch-up instalment!

3.   What are catch-up Instalments and how are they calculated?

To explain how this works, it is best to use an applied scenario: say you’ve been generating consistent income from your business for years and you’ve been paying tax instalments of $4,000 each quarter. However, in recent times, the business has really taken off and you’re making much bigger profits. What happens?

Well, until you lodge your next tax return, the ATO will be completely unaware that your business profits have surged. As such, you’d just continue to pay the $4,000 tax instalment each quarter.

Income tax: When it comes time to lodge your tax return for that growth year, you’d obviously expect to have some tax to pay. For the sake of this example, let’s assume the tax on your business profits was $40,000 when you lodged your tax return. Given you’d already paid four quarterly tax instalments of $4,000 each (i.e. $16,000 over the year), the ATO would issue you with a tax bill for $24,000 that year – $40,000 tax less the $16,000 in instalments already paid.

No one likes a big tax bill, but they generally hate what comes next even more!

The adjusting tax instalment: Continuing the scenario, let’s assume that when you lodged your tax return and received your $24,000 bill, you’d already paid three tax instalments of $4,000 each for the following tax year.

Upon receiving your tax return, the ATO finds out that your business has grown. As a result, they will now want to increase your tax instalments on the assumption that you’re going to continue earning similar profits.

You might expect that the ATO will reset your future instalments to $10,000 each – a quarter of the $40,000 tax from the previous year. Instead, they actually want to bring the tax instalments into line so that you’ll have paid $40,000 in tax instalments by the time this new year is complete. What does that mean? In the scenario, you’ve already paid $12,000 over the three instalments so far, so to bring the balance of the four tax instalments to $40,000, the ATO will want $28,000 in your next quarter’s tax instalment.

In quick succession, the ATO will want you to pay the prior year’s tax of $24,000 plus a balancing tax instalment of $28,000! All up, that’s $52,000! While your business might still be performing well and growing, you need to be aware of these potentially significant tax payments early so you can budget for the cash flow hit.

In the above example, once the adjusting tax instalment has been paid and a new financial year has begun, the quarterly instalments will revert to the new normal of $10,000 per quarter (being $40,000 divided into four).

4.   How do I best manage PAYG instalments?

Ideally, you’ll have put tax aside when the income was earned. If the money is sitting safely in a savings account, then it will always be there when the ATO issues their instalments. As for how much to put aside, this is a case-by-case situation. You can ask us for advice.

5.   Do I still need to pay PAYG instalments if I’m no longer earning the business/investment income?

Maybe. If your income has fallen or ceased, you will be able to reduce or cancel your PAYG instalments. However, if your income will remain the same or increases, you can’t reduce or cancel your PAYG instalments. Doing so will risk ATO penalties.

Help with PAYG Instalments

If you’re still not sure about PAYG instalments or have any other questions, please reach out. We’re here to make your life easier and sort out any confusion. With our help, you can get clear on how PAYG instalments apply to your business and keep your cash flow stable. We’re always available to help guide you on managing your PAYG Instalments.