What you need to know about PAYG Instalments!
Are you running your own business and want to make sure you are meeting your tax obligations? Whether you are a sole trader or have set up your own company, we want to assist you to reach your business’ full potential. Starting up a business is an extremely exciting time but be sure to have all your tax affairs in order before it becomes overwhelming! You need to lodge your tax return annually as you will know however once your tax payments reach a certain threshold, you (or your company) will need to pay quarterly tax instalments. These instalments fall under what is called the PAYG System, which is the Government’s mechanism for collecting tax from taxpayers during the year before their annual assessment is lodged. PAYG stands for “Pay As You Go”. The idea is to eliminate big one-off tax payments, for the benefit of both taxpayers and the Government.
The key aspects of the system are:
- To be required to make PAYG instalments you or the business needs to have reported more than $4,000 business or investment income in the previous income tax return. There are some exceptions, but those will not be relevant for this discussion.
- There are two methods for calculating the instalment;
- Commissioner’s instalment – ATO provides an instalment amount that is paid each quarter, which is based on the most recent assessment.
- Instalment rate – ATO provides a percentage rate to multiply income for the quarter to calculate the amount. The rate is based on rate of tax paid for most recent assessment. This is meant to better reflect actual business activity during the year compared to method 1.
- The trigger point to establish or reset the amount or rate is the lodgement and assessment of a tax return.
- The instalment or percentage rate can be varied up or down if circumstances have changed. However the ATO does have scope to penalise taxpayers for getting their variation too far off the mark. There needs to be a reason and a calculation behind a variation.
- After the first year, if profits and tax payments keep increasing, there will at some stage be a ‘catch up’ payment for a quarter.
As an example, consider a small business company with a 30 June year end that makes profit from year 1. The tax assessments will be as follows:
|Year 1||Year 2||Year 3|
|Tax return lodged||October||January||November|
|Tax at 27.5%||$8,250||$16,500||$27,500|
|Tax instalments paid||$0||$8,500||$17,000|
The tax instalments that arise on method 1 above will be as follows:
|Year 1||Year 2||Year 3||Year 4||Notes|
|Instalments for Year||$0||$8,500||$17,000||$28,500||1|
|Instalment Q1 due 28/10||$0||$0||$2,125||$4,250|
|Instalment Q2 due 27/2||$0||$4,250||$6,375||$10,000||2|
|Instalment Q3 due 28/4||$0||$2,125||$4,250||$7,125||2|
|Tax payable prior year due 15/5||$0||$8,250||$8,000||$10,500||3|
|Instalment Q4 due 28/7||$0||$2,125||$4,250||$7,125|
- The instalment for the year is the prior year tax payable, increased by an indexation amount. For this exercise it is simply rounded up, so year 1 tax of $8,250 is rounded up to $8,500 for the year 2 annual instalment amount. Year 1 cannot have an instalment amount, as no tax returns have been lodged before.
- The ‘catch up’ instalments fall into Q2 and Q3 in these examples based on the timing of lodgement of the tax return. The ‘catch up’ is based on the annual instalments, less any amount paid to date. For example;
- In year 3, the annual amount is $17,000. So each quarter should be $4,250.
- Halfway through the year the ATO should be paid $8,500. Q1 had $2,125 paid, so Q2 is simply $8,500 – $2,125.
- The annual tax payable is the prior year tax return balance and is separate to the ongoing instalments. This amount looks back, whereas the ongoing instalments are looking forward.