Understanding PAYG Instalments – Are you all over your PAYG calendar for 2021?

What’s the first thing that comes to mind when we say the words ‘Australian tax system’? Often, the word complicated comes straight to mind with many seeing the Australian tax system as a complex set of rules and regulations. Whilst this is quite often truth from the perspective of a small business owner, we can’t stress the importance enough of understanding the basics of our tax system.

When a small business or individual is first faced with the receipt of a PAYG (Pay as you go) Instalment notice, 2 questions are asked:

1. Do I have to pay this?
2. Why do I have to pay this?

In short, the answers are:

1. Yes, you have to pay this
2. Because the ATO (Australian Taxation Office) says so

Now what kind of advisor would I be if I gave these answers to a client and provided no additional explanation?  I know if I were in the client's shoes, that person would likely no longer be my advisor... 

So today we look into the dreaded world of PAYG Instalments – a godsend come 30 June but a pain every 3 months. It’s important to note here that the examples and calculations we’ll be looking into in today’s blog won’t apply to every business, person and situation. If you feel that your income is more sporadic, please get in contact to learn about alternative options that may be better fit for you.  

Believe it or not, paying tax used to be a whole lot more complicated. Thankfully, the new and improved system (which was introduced in 1998) condensed 11 different tax concepts into 2 simplified concepts; PAYG Instalments and PAYG Withholding. 

Today we’ll be focusing on PAYG Instalments. As a quick wrap-up of PAYG Withholding, anyone who has been an employee at some point in time should have a pretty good idea of how it works. Simply put, tax is withheld from your regular gross pay packet as a means of contributing towards your annual tax payable requirements.  

PAYG Instalments

To briefly summarise, PAYG Instalments are designed for individuals or companies to pre-pay a designated amount of tax in any one particular financial year.  The figures are calculated based on the taxpayer’s most recent tax return and this is used as a base to estimate your next financial year’s tax payable.  That estimate is then broken down into quarters and the taxpayer must then pay these instalments by the end of the upcoming financial year. 

We know that being faced with ATO requirements can feel a little daunting. Based on personal experience, I find the easiest way to understand PAYG Instalments is to use the example of store lay-bys. With lay-by you won’t receive your product until all instalments have been paid (no matter the size or value of the instalments). The benefit of lay-by, much like PAYG Instalments is that by splitting costs over a period of time, the financial burden is lessened and more dispersed.  

The following case study helps illustrate the pros and cons of the PAYG Instalment system!  

Employee: Employee X earnt $60,000.00 in gross salary in 2020 and in line with requirements, their employer withheld $11,067.00 of PAYG Withholding.  On top of this, Employee X has 3 rental properties and combined, these rental properties made a profit of $30,000.00 in 2020.   

Based on 2020 tax rates, the following can be seen: 

Please note: This case study ignores additional intricacies including individual deductions, special tax rates or concessions for businesses, Private health, and spouse income.  Examples should not be applied to real life scenarios due to the complex nature of Income Tax Law as the case study has intentionally been kept basic to avoid confusion.  

Calculating your PAYG Instalments 

Your PAYG Instalments are almost always based on the last tax return you have lodged with the ATO and this is the key reason it pays to be on top of your tax return lodgement when you are in the PAYG Instalments system.  The ATO calculates your PAYG Instalments based on last year’s tax payable and adjusts for GDP (Gross domestic product) which takes into consideration likely business growth that could be expected in the coming financial year. Considering our Employee X example, we look at calculations: 

Employee X – Based on the income submitted in Employee X’s 2020 income tax return, the tax paid was not sufficient to cover their 2020 tax bill and as a result, they were faced with a $10,450.00 tax bill – Uh Oh!  Based on this shortfall and the integration of the 2021 tax rates and regulations, the ATO will then project an amount which it will request the taxpayer to pay over the coming 12 months.  In this case it is estimated that the ATO would be requesting an amount of $9,270.00 in PAYG Instalments. 

Note: Estimated scenario is particularly unusual due to the impact COVID 19 has had on the economy in 2020 and will undoubtedly continue to have on the economy in 2021.  PAYG Instalments would not traditionally be lower or equal to prior year tax. Rather, they are almost always higher. 

PAYG Instalments are an ATO enforced requirement.  Payable each quarter, the ATO allows minimal leniency regarding these instalments and should you wish to vary, you must have solid evidence to support your claim for variation. The ATO do not look favourably on taxpayers who change the figure the ATO are asking you to pay in your instalments. Particularly, should this change result in a tax bill that could have been avoided by your paying their initial figure. Overall, this situation can result in interest and penalties being applied to the taxpayer, which is something we definitely want to avoid!  

Reverting to our example, we now look at timing.  Here we will use three 2020 tax lodgement scenarios; lodged 31 July 2020, lodged 31 January 2020 and lodged 15 May 2021.

Lodgement Date: 31 July 2020 (as lodged by tax agent) 

Lodgement Date: 31 January 2021 (as lodged by tax agent) 

Lodgement Date: 15 May 2021 (as lodged by tax agent) 

 Note: Payment of Income tax for prior year is dependent on a number of factors based on your personal and business circumstances.  Always check with your tax practitioner if you’re unsure about anything at all!  

As you can see based on the above, the date you lodge your tax return can have a significant impact on your cash flow.  Therefore, we encourage all clients to lodge their tax return as soon as feasibly possible, particularly if you’re a new business owner!   

You may have noticed in each of the three scenarios, the net cash outflow is exactly the same.  This loops back to what we discussed earlier about PAYG Instalments being an ATO enforced requirement.  Delaying lodgement to avoid this requirement only pushes the date the total sum is due, meaning you are left with a compounding effect and will need to pay it all at once. Imagine all your regular bills and payroll duties rolling around like usual then you’re required to fork out another $10,000... definitely not ideal!  

New to PAYG Instalments?  

It’s important to note that year 1 of the PAYG Instalments system will always be the most difficult so if you're feeling overwhelmed take a deep breath! Your first year will be the trickiest because you’re faced with paying last year’s tax bill as well as get organised and start pre-paying PAYG instalments for the coming years tax.  

As we move into the second year, assuming your income remains the same, you won’t be faced with such a large tax bill because you have contributed each quarter in that financial year.  This means that the cash flow for your tax payments is evened out and the tax bill should feel a little more manageable. 

If you are someone who has a minor obsession with planning and organising (we all know that one person), you can elect yourself into the PAYG Instalments system.  The ATO will love you and your advisor would only be too happy to assist you in preparing some estimates. 

As your trusted tax advisor, your accountant should always walk through the PAYG Instalments process with you, ensuring you understand the implications, requirements and finer detail around the program. If you feel that your accountant has left you in the dark or isn’t giving you the time, you deserve, give us a call today on 1300 932 584 to experience the K+P difference.   

Tax planning is a great tool that any advisor will offer as it helps you understand and plan for cash flow management and assess due dates and deadlines in advance. Get started today and book a discovery session here.