Pay As You Go (PAYG) instalments are one of the more frequently misunderstood items in a business's BAS. Clients often confuse them with PAYG withholding (the tax withheld from employee wages), and many don't understand why they're paying income tax quarterly when their tax return hasn't been lodged yet.
This guide explains how PAYG instalments work, how the ATO calculates instalment amounts, when and how to vary them, and the bookkeeping treatment.
What PAYG Instalments Are
PAYG instalments are pre-payments of income tax for individuals and entities with business or investment income. The system exists so that income tax is collected progressively throughout the year, rather than as a large liability at lodgement time.
Once a business (or individual with investment income) meets the income threshold, the ATO automatically enters them into the PAYG instalment system. The first instalment notice typically arrives after the first income tax return is lodged that exceeds the threshold.
Who enters the system:
- Individuals with business income or investment income above $4,000 in their last income tax assessment
- Companies with tax payable above $500 in their last assessment
- Trusts and partnerships in certain circumstances
Who doesn't:
- Salary and wage earners whose employer already withholds tax (they don't have additional business income)
- Businesses with no taxable income
Two Methods: T or W
The ATO offers two methods for calculating quarterly PAYG instalments:
Option T — Instalment Amount
The ATO calculates a notional tax amount based on your last income tax assessment and sends it on the BAS. You simply pay the amount the ATO has calculated. No calculation required.
The notional tax figure is derived from last year's actual tax liability, adjusted by an GDP adjustment factor (an indexation factor the ATO publishes annually). For 2025–26, the GDP adjustment factor is 11%.
The T option is the default and suits most clients because it requires no calculation — you pay what the ATO says.
Option W — Instalment Rate
Instead of a fixed dollar amount, the ATO provides an instalment rate (expressed as a percentage). You apply that rate to your actual quarter's business income to calculate the instalment.
The W option is useful when income fluctuates significantly quarter-to-quarter, because the instalment tracks actual income rather than last year's estimate. It requires more active calculation but avoids over-paying in low-income quarters.
Quarterly vs Annual Lodgement
Most businesses lodge quarterly BAS, meaning PAYG instalments are paid four times per year: October, February, April, and July. The July quarter covers April–June; the October covers July–September.
Certain smaller businesses lodge annual BAS (annual turnover under $10M, generally). For annual lodgers, PAYG instalments are typically included as a single annual amount in the annual BAS.
Varying the Instalment
Here is where most of the practical bookkeeping and advisory work sits. If a client's current year income is expected to be materially different from last year, the instalment amount (or rate) can be varied.
Variation is reported at Label T7 on the BAS. You enter the varied amount and a variation reason code.
When to vary down:
- Business income has declined significantly this year (e.g., major client lost, economic downturn)
- Client is in a loss position for the year
- Significant deductions in the current year that weren't present last year (asset purchase under IAWO, large R&D expenditure)
When to vary up:
- Income is materially higher than last year — over-variation is not penalised, but it reduces the end-of-year top-up
The penalty for varied instalments: If the client varies their instalment down and the actual tax liability at year-end exceeds the varied amount by more than 15% of the actual liability (or $2,000, whichever is greater), the ATO charges the General Interest Charge (GIC) on the shortfall from the due date of each instalment. GIC is currently around 11.38% per annum.
The message for bookkeepers: variation is legitimate and encouraged when income is genuinely lower, but it shouldn't be used to defer payment without justification — the interest charge can be significant if the variation is too aggressive.
Bookkeeping Treatment
PAYG instalments are not an expense — they are pre-payments of income tax. They sit on the balance sheet as a tax asset until the income tax return is lodged and the final liability is calculated.
At time of payment (each quarter):
- Dr Income Tax Payable (or PAYG Instalment Asset)
- Cr Bank
At year-end, when actual tax liability is determined:
- If tax payable > instalments paid: Dr Income Tax Expense, Cr Income Tax Payable (for the balance owed)
- If tax payable < instalments paid: Dr Income Tax Payable, Cr Income Tax Refund Receivable (or Dr Bank if refund received)
For companies, the year-end income tax provision is a separate calculation from the instalments. The instalments are credited against the company tax liability when the return is assessed.
For small business owners using simple cash accounting, PAYG instalments are sometimes coded directly to a "tax paid" account. This is acceptable for management purposes but should be clearly labelled so the tax agent can find the year-to-date total when preparing the return.
The ATO's Annual Reconciliation
When the income tax return is lodged and assessed, the ATO reconciles:
- Tax payable per the assessment
- Less: PAYG instalments paid during the year
- = Balance payable (or refund owing)
If the client has paid too much in instalments, they receive a refund — typically within a few weeks of the assessment being issued. If too little, the balance is due.
For bookkeepers, this means the tax liability shown in management accounts during the year is a forecast — the final number isn't known until the return is assessed. For companies in particular, a reasonable provision for current-year income tax should be estimated and recorded at each balance date.
Common Errors
Coding instalments as "tax expense" — PAYG instalments are a balance sheet item until the final liability is struck. Expensing them as paid understates profitability in quarters when instalments are paid and distorts monthly P&L.
Not varying when income has dropped — clients who have had a bad year sometimes continue paying the prior-year instalment amount without varying, creating a refund at year-end. This is a cash flow opportunity: the money could stay in the business until needed.
Confusing PAYG instalment with PAYG withholding — they appear on the same BAS form. Instalments are the entity's own income tax. Withholding is tax deducted from employee wages and remitted to the ATO on the employees' behalf. These are separate obligations reported at different labels.
Missing an instalment — each instalment has a due date on the BAS lodgement schedule. Missing it triggers the GIC on the outstanding amount.
Practical Tips
- Review the notional amount at the start of each quarter — if it looks out of line with current-year income, raise a variation
- Document any variation — if income is down for a reason (client departure, reduced activity), record the reason at the time so there's context if queried later
- Reconcile instalments to the tax return — the sum of quarterly instalments should equal the amount creditable against the final assessment
- Check the instalment rate (W option) when income is highly seasonal — lodging a nil or low W instalment in a genuine low-income quarter is preferable to overpaying and waiting for a year-end refund
PAYG instalments are a cash flow tool as much as a compliance obligation. Bookkeepers who actively monitor and vary them when warranted provide genuine value to their clients.