PAYG Withholding vs PAYG Instalments - The Difference

20 February, 2025 · 11 min read

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Compare PAYG Withholding and PAYG Instalments to understand their differences, how they work, and their impact on your tax obligations.

Australian Tax System in a Nutshell
The Pay As You Go (PAYG) System: A Broad Overview
What is PAYG Withholding?
What are PAYG Instalments?
Who Must Pay PAYG Instalments?
Scenarios Illustrating PAYG Withholding vs. PAYG Instalments
PAYG Withholding vs PAYG Instalments: Key Differences
Common Mistakes and How to Fix Them
Conclusion
How Can ANNA Simplify Your Tax Management?

Regarding the Australian taxation system, one of the commonly encountered acronyms is “PAYG” – which stands for “Pay As You Go.”

But while the acronym might seem straightforward, the system itself comprises a couple of different components that have different purposes: PAYG Withholding and PAYG Instalments. If you’re a business owner, a freelancer, or simply curious about how taxes are paid in Australia, understanding these two aspects of the PAYG framework is crucial.

Australian Tax System in a Nutshell

Before diving into the specifics of PAYG Withholding and PAYG Instalments, it’s helpful to take a quick look at the broader Australian taxation framework.

Australia operates under a progressive tax system for individuals, which means that different portions of your taxable income are taxed at different rates.

The Australian Taxation Office (ATO) is the governing body responsible for administering and collecting taxes from both individuals and businesses.

For many people, taxes are automatically taken out of their salary by their employer. However, not all sources of income are the same.

Some forms of income, such as business or investment income, may require taxpayers to pay tax in a different way – often through instalments.

This leads us to the concept of the Pay As You Go (PAYG) system.

The Pay As You Go (PAYG) System: A Broad Overview

At its core, Pay As You Go is a method of pre-paying your taxes as you earn your income throughout the year, rather than waiting until you lodge your annual tax return.

The intention is to avoid a large lump-sum tax bill at the end of the financial year and to assist the government in collecting revenue consistently.

There are two primary streams under the PAYG umbrella:

PAYG Withholding – for amounts withheld by employers or other entities from payments such as salary, wages, and certain other forms of income.
PAYG Instalments – for individuals and businesses who pay their tax liabilities in instalments throughout the year, usually because they earn business or investment income.

By splitting the system in this way, the ATO can more efficiently manage and monitor the tax that needs to be collected.

What is PAYG Withholding?

PAYG Withholding is the system that requires employers (and certain other entities) to withhold tax from payments to employees, contractors, or other payees.

This process ensures that individuals pay tax gradually throughout the year on their employment or certain other income, rather than facing a large bill at tax time.

Examples of Payments Subject to PAYG Withholding

Salary and wages: If you work as an employee, your employer withholds a portion of your pay based on your tax file number (TFN) declaration and the tax tables provided by the ATO.
Directors’ fees: Company directors are also subject to withholding on their remuneration.
Contractor payments (in certain situations): If a contractor fails to provide an ABN (Australian Business Number), payers may need to withhold an amount (often the top marginal rate) from payments for their services.
Superannuation income streams: In some cases, tax may be withheld from pension or annuity payments.
Payments of interest, dividends, or royalties to non-residents: Entities making these kinds of payments to non-residents are required to withhold tax.

Responsibilities for Businesses Under PAYG Withholding

If you run a business that employs staff (or pays contractors where withholding applies), you need to:

Register for PAYG Withholding: You can do this through the Australian Business Register (ABR) or by contacting the ATO directly.
Withhold the Correct Amount: You’ll use the ATO’s tax tables or the employee’s TFN declaration to figure out how much tax to withhold from each payment.
Report and Pay Withheld Amounts: Usually, businesses report and pay withheld amounts to the ATO through their Business Activity Statements (BAS) on a monthly or quarterly basis.
Provide Payment Summaries (Now Known as Income Statements): Under Single Touch Payroll (STP), most employers report to the ATO in real-time, and employees’ payment summaries are often accessible via myGov. However, the concept remains that employees receive records of how much tax has been withheld.
Keep Accurate Records: Documentation of all withheld amounts, employee details, and payment confirmations should be maintained for compliance and auditing purposes.

The Aim of PAYG Withholding

The core idea behind PAYG Withholding is straightforward: Ensure that employees and certain payees don’t accumulate a huge tax debt at the end of the financial year.

Instead, the tax is steadily withheld and sent to the ATO.

When individuals lodge their tax returns, the withheld amount is taken into account, and any overpayment is refunded, while any shortfall must be paid.

What are PAYG Instalments?

While PAYG Withholding is about withholding tax from employee wages or certain other payments, PAYG Instalments are the mechanism by which individuals and businesses pre-pay their own tax liabilities in instalments throughout the year.

This commonly applies to:

Self-employed individuals
Small business owners
Individuals with significant investment income (e.g., rental properties, share dividends if not fully franked, or interest income)

The purpose of PAYG Instalments is to ensure that people who don’t have an employer withholding tax on their behalf throughout the year don’t end up with a massive tax bill when they lodge their return.

How Do PAYG Instalments Work?

The ATO typically notifies you if you’re required to enter the PAYG Instalments system. This usually happens if:

Your tax payable on your latest tax return was over a certain threshold (often in the thousands of dollars range).
You earn business or investment income above a certain limit.
You have a history of owing the ATO money when you lodge your tax return.

Once you’re in the system, you’ll be required to pay a portion of your estimated annual tax liability in regular instalments (often quarterly, but sometimes monthly for larger businesses). The ATO calculates an instalment rate or uses an instalment amount based on your most recent tax information.

You then apply this rate (or amount) to your current business or investment income.

Key Points About PAYG Instalments:

Instalment Rate: The ATO may provide a rate based on information from your previous tax return. If you choose the “instalment rate” option, you’ll multiply your current income by the rate each quarter (or each month) to determine how much to pay.
Instalment Amount: Alternatively, you may receive a predetermined instalment amount from the ATO. You can either accept this amount or vary it if you believe your income will be significantly different.
Frequency of Payments: Most commonly, small businesses and individuals with simpler affairs pay quarterly. Larger businesses with higher withholdings or GST turnover might pay monthly.
Variation: If your circumstances change – say your income significantly increases or decreases – you can vary your instalment amount or rate to avoid underpaying or overpaying your taxes.

Reporting and Paying PAYG Instalments

Like PAYG Withholding, you’ll report and pay your PAYG Instalments via your Business Activity Statement (BAS) or Instalment Activity Statement (IAS).

The frequency with which you lodge these statements depends on the size and structure of your business or your personal tax obligations.

After the end of the financial year (June 30 in Australia), you’ll still lodge your tax return as normal.

The instalments you’ve already paid will be credited against your total tax liability for that year, leaving you with either a smaller amount to pay or a refund if you’ve overpaid.

Who Must Pay PAYG Instalments?

While the ATO may automatically sign you up for PAYG Instalments if you meet certain criteria, it’s helpful to know the general guidelines to see if you might be affected:

You Earn Business Income: Whether you operate as a sole trader, partnership, trust, or company, if you generate significant profit, you’re likely to be required to pay PAYG Instalments.
You Have Investment Income Above Thresholds: Individuals with substantial investment income, like rent, dividends, interest, or capital gains, often are required to pay instalments.
You Consistently Owe the ATO at Tax Time: If your tax payable after lodging returns regularly exceeds the threshold set by the ATO, you’ll probably be brought into the system.

If you’re unsure about whether you need to pay PAYG Instalments, you can contact the ATO or consult with a registered tax agent to get clarity.

Scenarios Illustrating PAYG Withholding vs. PAYG Instalments

Let’s take a look at a couple of hypothetical scenarios to clarify how these systems come into play:

Scenario 1: Sarah the Employee

Income Source: Sarah works for ABC Pty Ltd as a marketing manager, earning a salary of AUD 80,000 per year.
PAYG Withholding: Each fortnight, ABC Pty Ltd withholds a certain amount of tax from Sarah’s pay based on the ATO tax tables. This withheld amount goes to the ATO when the company lodges its monthly or quarterly BAS. Sarah doesn’t have to worry about paying PAYG Instalments because her employer is already taking care of withholding tax on her behalf.
Tax Return: At the end of the financial year, Sarah lodges her tax return. The withheld amounts are credited against her final tax liability, and she either receives a refund or pays a small balance if necessary.

Scenario 2: Tom the Sole Trader

Income Source: Tom runs a small graphic design business as a sole trader. He invoices clients directly for his services and doesn’t receive a salary from an employer.
PAYG Withholding: Not applicable in the traditional sense, as Tom does not have an employer withholding tax from his income. If Tom hires employees or contractors (who don’t provide ABNs), he may need to withhold tax from their payments, but that’s separate from his personal income.
PAYG Instalments: The ATO sends Tom a letter indicating he needs to pay PAYG Instalments. He opts for the instalment rate method, applying the ATO-provided rate to his business income each quarter and paying that amount via his BAS.
Tax Return: After the financial year, Tom calculates his actual taxable income and lodges his tax return. The instalments he paid throughout the year reduce his final tax bill.

Scenario 3: Emma the Investor

Income Source: Emma works part-time (earning around AUD 30,000 per year), but also has substantial rental and investment income that amounts to an additional AUD 50,000 per year.
PAYG Withholding: Emma’s part-time employer withholds PAYG on her $30,000 salary.
PAYG Instalments: Because Emma’s overall tax liability for her rental and investment income is substantial, the ATO notifies her she must pay PAYG Instalments on that $50,000. She receives quarterly IAS forms and pays an instalment based on the ATO’s rate.
Tax Return: At the end of the year, the combined tax withheld from her part-time wages and the PAYG Instalments on her investment income are credited against her final tax liability.

PAYG Withholding vs PAYG Instalments: Key Differences

Now that we’ve defined both systems, let’s distill the information into the core differences between PAYG Withholding and PAYG Instalments.

1. Who Pays and Who Withholds?

PAYG Withholding: The employer (or payer) withholds tax from an employee or payee’s income and remits it to the ATO.
PAYG Instalments: The individual or business itself pays tax to the ATO in instalments on their business or investment income.

2. Source of Income Covered

PAYG Withholding: Employment income, director’s fees, certain contractor payments (when no ABN is provided), certain payments to non-residents, and some pension or annuity streams.
PAYG Instalments: Self-generated income outside of standard employment wages, including business profit, rental income, investment earnings, and any other income not covered by PAYG Withholding.

3. Reporting Mechanism

PAYG Withholding: Generally reported on the employer’s Business Activity Statement (BAS).
PAYG Instalments: Also reported via the BAS or Instalment Activity Statement (IAS), but based on the entity’s or individual’s instalment rate or amount.

4. Timing

PAYG Withholding: Withheld and reported when employee wages (or other relevant payments) are made, usually weekly, fortnightly, or monthly, then reconciled on BAS cycles (monthly or quarterly).
PAYG Instalments: Paid quarterly or monthly (in specific cases) based on projected or actual income.

5. Legislative Obligation

PAYG Withholding: The obligation is on the employer (or payer) to deduct and remit the amount to the ATO.
PAYG Instalments: The obligation is on the individual or business to pay the instalments on time.

6. Compliance Risks

PAYG Withholding: Not withholding correctly can lead to penalties and interest charges for the employer.
PAYG Instalments: Failing to pay instalments or underpaying can result in general interest charges (GIC) and penalties.

Common Mistakes and How to Fix Them

Both systems can cause confusion for individuals and businesses. Below are some frequent errors to watch out for:

❌ Failing to Register for PAYG Withholding: If you start employing staff or paying contractors who do not provide ABNs, you must register for PAYG Withholding. Overlooking this can result in penalties.

❌ Incorrect Withholding Amounts: Using outdated tax tables or not updating TFN declaration details can lead to mistakes in how much tax is withheld. Always check the ATO website for the most current information.

❌ Missing Deadlines: Late lodgement of BAS or IAS statements can trigger fines and interest charges. Mark the due dates on a calendar or use reminders.

❌ Underestimating Business or Investment Income (PAYG Instalments): If you underestimate your income too severely when varying instalments, you could face a large shortfall and potential penalties at year’s end.

❌ Not Varying Instalments When Needed: On the flip side, if your income drops significantly and you don’t vary your instalments, you might pay too much throughout the year. While you’ll usually get a refund, it ties up your cash flow unnecessarily.

❌ Poor Record-Keeping: Accurate and up-to-date records of all payments, withholdings, and instalments are essential. Lax record-keeping makes it harder to lodge your tax returns correctly and can raise red flags during audits.

Conclusion

Understanding the difference between PAYG Withholding and PAYG Instalments is essential for anyone earning income in Australia, whether as an employee, a contractor, a business owner, or an investor.

While PAYG Withholding handles the automatic deduction of tax from employees’ salaries and certain other payments, PAYG Instalments ensures that people who earn business or investment income throughout the year aren’t hit with an unmanageable tax bill at the end.

How Can ANNA Simplify Your Tax Management?

ANNA is an all-in-one solution that makes tax management simple for Australian businesses. From registration to filing, ANNA handles key tasks so you can focus on running your business.

1. Comprehensive Tax Coverage

Company Income Tax: ANNA calculates and tracks your liabilities, so you’re always aware of upcoming obligations.
GST Management: Simplify BAS lodgements by automatically tallying your sales and expenses in real time.
Annual Filings: ANNA organises all the data you need to lodge your end-of-year tax return confidently.

2. Powerful Features

Real-Time Tax Estimates: Keep an accurate, up-to-date view of your tax position to avoid surprises at year-end.
Expense Logging: Classify deductible expenses quickly and easily for maximum tax savings.
Profit Tracking: Monitor your profits and cash flow, so you can plan for PAYG Instalments and other outlays.
ATO Filing Support: Submit returns directly through ANNA with clear, automated summaries, eliminating guesswork.

3. Straightforward Process

Connect Your Bank Accounts: Import your business transactions seamlessly into ANNA.
Receive Real-Time Estimates: Automated calculations show exactly how much tax you owe at any point.
Customise Your Data: Make manual adjustments to ensure your records reflect every detail accurately.
File with Ease: ANNA guides you step by step, helping you meet ATO deadlines and avoid penalties.

Ready for hassle-free tax management?