Pay As You Go (PAYG) instalments are quarterly prepayments of expected income tax made to the Australian Taxation Office (ATO). They apply to businesses and individuals with investment income above certain thresholds, smoothing the tax burden across the year instead of creating one large annual liability. Getting the bookkeeping right matters: misclassified or omitted instalment entries distort profit-and-loss reports and create surprises at lodgement time.
Who Enters the PAYG Instalment System
The ATO automatically enrolls taxpayers whose most recent tax return shows instalment income above $4,000 and a tax liability above $1,000 (or $2 for entities in the investment income stream). Instalment income broadly means business income plus most investment income — it excludes GST-inclusive revenue and most capital gains.
Once enrolled, the ATO notifies you via your Activity Statement. You can also voluntarily enter the system if you want to avoid a large year-end payment, which is common for new businesses anticipating strong first-year profits.
Two Methods: Amount vs Rate
The ATO offers two calculation methods. You elect which to use on each Activity Statement — you can switch freely each quarter.
Instalment amount method: The ATO calculates a GDP-adjusted notional tax figure based on your previous return and tells you the dollar amount to pay. This is the default for most small businesses. The ATO's figure is generally a reasonable estimate, but if your income has changed materially you should vary (see below).
Instalment rate method: The ATO provides a rate (expressed as a percentage). You multiply that rate by your gross instalment income for the quarter to arrive at the payment. This method is more accurate for businesses with seasonal or variable income, because the payment automatically rises and falls with revenue.
Varying Your Instalments
You can vary your instalment amount downward (or upward) if you believe the ATO's figure will result in an overpayment or underpayment. Variations are entered on your Activity Statement before lodgement. If you vary down and your actual tax liability turns out to be higher, the ATO may apply the GDP uplift penalty — currently 10 percentage points — to the shortfall amount. The penalty does not apply if your varied payment is at least 85% of your actual liability.
Common reasons to vary include: lower-than-expected revenue in a quarter, a one-off deductible capital expense, a loss from a related entity, or a change in business structure mid-year.
Bookkeeping Entries
Treat each PAYG instalment payment as a tax prepayment (asset), not an expense. When the payment is made:
DR PAYG Instalments Prepaid (asset) $X,XXX
CR Bank $X,XXX
At year-end, when the actual income tax expense is determined (usually on completion of the tax return or through a tax provision), reclassify:
DR Income Tax Expense $X,XXX
CR PAYG Instalments Prepaid (asset) $X,XXX
Any residual balance — instalments paid in excess of the final liability — flows back as a tax refund receivable. Any shortfall becomes income tax payable. Under accrual accounting for larger entities, a periodic tax provision is raised quarterly rather than waiting for the final return.
Activity Statement Reporting
PAYG instalments appear in the T section of the Quarterly Business Activity Statement (quarterly BAS) or the Instalment Activity Statement (IAS) for those not registered for GST. The key labels:
- T1 — instalment income (rate method only)
- T2 — instalment rate (provided by ATO, rate method only)
- T4 — reason for variation (if varying)
- T11 — instalment amount payable (amount method, or the result of T1 × T2)
ReconLink's BAS worksheet automatically pre-fills T11 from the prior ATO notice; you override it when you vary.
Annual Reconciliation
At tax return time, total instalments paid during the year are credited against the assessed tax liability. If instalments exceed the liability, the ATO refunds the surplus (typically within 30 days of assessment). If there is a gap, the balance is due by the return due date — usually 31 October for self-preparers or a later date negotiated through a registered tax agent.
For companies, the instalment income threshold is the same $4,000, but the instalment rate the ATO issues is calibrated to the applicable company tax rate — 25% for base rate entities or 30% for larger corporates.
Common Errors
Coding instalments to expenses: Recording the payment directly to "income tax expense" skews the profit and loss before year-end and makes BAS reconciliation harder. Always use a balance sheet prepaid account.
Forgetting to vary after a bad quarter: Many small business owners pay the ATO's default amount even in a loss quarter. A timely variation preserves cash flow and avoids an overpayment sitting with the ATO for months.
Missing the lodgement deadline: PAYG instalment Activity Statements are generally due 28 days after the end of each quarter (28 October, 28 February, 28 April and 28 July), with the June quarter extended to 28 July. Lodging via a registered tax agent typically extends these dates.
Legislation and Further Reading
PAYG instalments are governed by Division 45 of Schedule 1 to the Taxation Administration Act 1953 (Cth). The ATO's guidance is published at ato.gov.au under "PAYG instalments." For entities transitioning from no instalments to the system for the first time, the first quarterly notice from the ATO constitutes entry — no separate application is required.