PAYG instalments are one of those ATO systems that most business clients find frustrating because they are paying tax on income they have not yet received in full. But the logic is sound: it smooths the tax liability across the year rather than landing a large bill after the return is filed.
What triggers PAYG instalments?
The ATO enters an entity into the PAYG instalment system when tax payable on the most recent income tax return exceeds the entry threshold, or the entity has investment income above the threshold. Once entered, the system continues until a return shows the tax payable falling below the exit threshold.
The two payment methods
Method 1 - Instalment amount: The ATO calculates a fixed dollar amount for each quarter based on your income from the prior year return. No calculation required.
Method 2 - Instalment rate: The ATO provides a percentage rate. You apply it to your gross business income for the quarter and pay the result. This is more accurate when income fluctuates significantly.
When to vary
You can vary your instalment amount or rate if you believe your actual tax liability for the year will be lower than the instalments are tracking to.
Common reasons to vary down:
- Business income is significantly lower than the prior year
- A one-off income item in the prior year inflated the base
- The entity has losses from prior years that will offset taxable income
The variation is lodged on the BAS at label T7 or T8. You simply enter a new instalment amount or rate.
The shortfall penalty
Under current ATO rules for the 2025–26 financial year, if you vary down and the actual tax liability turns out to be higher than 85% of the final tax payable, the ATO charges the GDP-adjusted shortfall rate on the gap. The 85% threshold is the safety margin: if the varied instalments cover at least 85% of the actual liability, no shortfall penalty applies.
Practical workflow for bookkeepers
For clients with variable income, the quarterly process is:
- Run a P&L for the year to date
- Project forward to 30 June based on the current trend
- Apply the prior year effective tax rate to projected taxable income
- Compare to total instalments at the ATO notified rate
- If the tracked liability is materially lower, discuss a variation
The key discipline is timing: variation decisions work best early in each quarter, not in the week before the BAS is due.
Quarterly due dates
- Q1 (Jul-Sep): due 28 October
- Q2 (Oct-Dec): due 28 February
- Q3 (Jan-Mar): due 28 April
- Q4 (Apr-Jun): due 28 July
Tax agents get an extended due date of 28 August for the Q4 instalment when lodging electronically.
Exit from the system
An entity exits the PAYG instalment system when a lodged return shows tax payable below the exit threshold. If a client exits after a low year but expects income to rise, proactively entering the system avoids the year-end cash flow shock of a large tax bill on lodgement.