I don’t think a day would go by when we are not asked about PAYG Instalment. It causes a great deal of confusion and distress for tax payers. The tax office letters that are issued are written in ATO language which means no one can easily understand them. Perhaps this will in some way help you to interpret what this is all about.
If you are older you may remember this as “Provisional Tax”. When the New Tax System was introduced in 2000 the name was changed to PAYG Instalment. Personally, I prefer to call it Advance Tax – because that is essentially what it is.
Advance Tax is levied on taxable income that is earned outside of your normal wages and salaries income. Wage and Salary income has tax deducted by your employer, but other sources of income (business or investment income) are only taxed when your income tax return is lodged. The ATO prefer regular payments of this tax so they call it in, typically on a quarterly basis. If you are lodging a quarterly Business Activity Statement it will be incorporated in your calculation. If you do not lodge a BAS you will be issued with an Instalment Activity Statement to make this payment. If the amount is very small you may elect to pay it on an annual basis, but for the majority of tax payers this becomes a quarterly event.
The tax office base your instalment amount on what they know about you. That information comes from the last income tax return you have lodged. The ATO are not aware of any changes in your business activity, or your investments. It is entirely based on the assumption that if you had to pay tax in one year then you will need to pay the same amount of tax again in the next year.
In the perfect world
In the perfect world (according to the ATO) you would lodge your tax between July and August. The ATO would be aware of the tax you needed to pay on your business and investment income and work out the appropriate instalment amount. We will use the example of a taxpayer with $8,000 in tax on business income that was payable in the 2019 tax year (as the next couple of years aren’t a great example for steady income).
The ATO will be expecting the taxpayer to earn a similar amount of business income in 2020. In fact, they anticipate that they will need to pay a little more than that as they expect the business income to increase in 2020 (called a GDP adjustment). The GDP adjustment for 2020 is 5% so the ATO will expect the taxpayer to be paying $8,400 in tax in 2020.
The ATO will then ask for $2,100 in PAYG Instalment in September 2019, December 2019, March 2020 and June 2020. When the taxpayer lodges their tax return for 2020 the actual tax for the year will be calculated. The $8,400 will be deducted from this calculation so they will not have as much to pay at tax time. If your tax is less than the $8,400 they will get a refund for the difference. Essentially, the tax payments are spread throughout the year rather than having them all paid in one hit.
It is not always a perfect world
There are plenty of variations on the above assumption and often this is where the confusion lies. I will discuss a few of things that can happen and try to explain them.
1. You do not lodge your return in July / August. If this is the case the instalment that has been missed will be caught up in the first instalment payment you need to make. We will use the above example and assume you lodged your return in October. The first instalment will be on the December BAS and that will be for $4,200, followed by $2,100 in March and June. The higher first payment causes a lot of stress for many tax payers.
2. The above example can be very stressful for new business owners who don’t lodge their return until around May. They will not only receive a tax bill for their 2019 income tax in May, they will also receive a full year of Instalment in June for a similar amount. Unless they are aware of this and have been setting aside money, the cashflow implications can be immense.
3. We see more confusion when you are already in the PAYG Instalment system and you lodge your income tax return. The ATO will send out a letter adjusting your PAYG Instalment amount and it will be based on a combination of what you have already paid for the year, and what you are needing to pay for the year. The letter you receive tells you how much you need to pay for the entire year (which is sometimes a big scary figure) and we suggest that tax payers wait to see what is on the next Activity Statement before they panic too much.
Alternative calculation methods
The ATO will give you the option of how you wish to calculate your PAYG Instalment on the first BAS that is issued with instalment in the income tax year. The options are to pay the calculated amount, or to pay an amount based a percentage of your turnover. The percentage you are to use will be provided by the ATO.
The percentage method can be advantageous for business owners who have cycles in their business income. If the business has high sales, more “advance tax” will be paid. If the business is not turning over as much, less “advance tax” will be paid. Note, the calculation is based on turnover not profit so the alignment is not perfect. The method you use is your choice.
If you do not make a choice the predetermined fixed amount will be applied, even if you have not lodged your forms with the ATO. There are taxpayers out there who ignore correspondence from the ATO only to find that a number of instalment amounts have been applied to their tax accounts. This is more common for individual taxpayers who have investment income as they are not preparing regular activity statements. This is often first realised when the debt collectors come chasing.
Can the PAYG Instalment amount be varied?
It can, but is should only be varied if there is a reason for it. The most common reason is that there is a “significant change” in the business or investment income. You may also vary your instalment if there is a change in the business structure, or if the business is not continuing. We suggest you discuss variations to your PAYG Instalments with your accountant.
One note on this, the instalment can only be varied for the current income tax year. Everything is reset on 1 July. Unless the ATO know otherwise, the Instalment amount that had been varied is likely to reappear/readjust on your September BAS. It may need to be varied again for the new financial year if you want the varied amount to continue.
PAYG Instalment is not something to be feared. It is not a new tax. It is just a “prepayment” plan for the tax you are going to have to pay at year end. If you are in any doubt speak with us and we can advise if the instalment still seems relevant to your business performance and guide you if there is a need to revise the amount. We always suggest setting some money aside for tax on a weekly basis so there is no big shock when those tax bills do arrive from the ATO. Tax is a part of life and a part of doing business. You only pay tax if you are making money, and ultimately that is what it is all about.