Pay As You Go (PAYG) withholding is the mechanism by which employers collect income tax on behalf of their employees and remit it to the ATO. It is one of the highest-stakes compliance obligations a bookkeeper manages — because errors don't just create a liability for the business, they can create personal liability for the company's directors.
This guide covers the core PAYG withholding obligations, how to calculate withholding correctly, the reporting requirements under Single Touch Payroll, and the consequences of getting it wrong.
What PAYG Withholding Covers
Employers must withhold PAYG from:
- Salary and wages paid to employees
- Directors' fees
- Return-to-work payments
- Termination payments
- Certain contractor payments (where the contractor doesn't quote an ABN)
PAYG withholding does NOT apply to genuine contractor payments where the contractor quotes a valid ABN. But as discussed in our contractor vs employee article, the classification of "contractor" is not solely within the employer's control — the ATO's tests apply regardless of what the contract says.
Calculating Withholding
The ATO publishes tax withholding tables (the Schedule 1 — Statement of formulas for calculating amounts to be withheld) that specify the withholding amount for each pay period based on the employee's earnings and any adjustments declared on their Tax File Number declaration or Withholding declaration.
Modern payroll software calculates this automatically — but bookkeepers should understand the adjustments that affect the calculation:
Tax file number declaration. Employees complete a TFN declaration when they start. If they claim the tax-free threshold (which they can only claim from one employer), the withholding is lower. If no TFN declaration is received within 28 days, the employer must withhold at the maximum rate (47%).
Tax offsets. Employees who claim a HELP debt (student loan) have an additional percentage withheld. Medicare levy exemptions reduce withholding. These are declared on the TFN declaration or Withholding declaration.
Extra withholding requests. Employees can request additional withholding — for example, to cover a side business income or rental income that will result in a tax bill at year end. This is common for employees who have significant investment income outside their salary.
Allowances. Some allowances are subject to withholding; others are not. A travel allowance up to the ATO's reasonable allowances amount is generally not subject to withholding. A car allowance that doesn't reflect actual costs typically is. The distinction matters.
STP Reporting Requirements
Single Touch Payroll Phase 2 is now fully operational for all employers. Each pay run must be reported to the ATO on or before the payment date (or by the day of payment at the latest). Key obligations:
Disaggregated reporting. STP Phase 2 requires employers to report each component of pay separately: ordinary hours, overtime, allowances, leave entitlements, salary sacrifice amounts. This disaggregated reporting replaces the old practice of reporting a gross salary figure.
Income types. STP Phase 2 introduced income type classification. Most employees receive "Salary and wages" — but working holiday makers, labour hire, and closely held payees have different income type codes that must be correctly applied.
Closely held payees. Directors and family members working in the business who are paid irregularly are "closely held payees." They have different reporting rules: they can be reported quarterly rather than per pay event, and their withholding can be calculated on a quarterly basis.
STP finalisation. At EOFY, employers must finalise their STP data — confirming that the year-to-date figures in STP are correct. Finalisation replaces the old payment summary (group certificate) process. Employees access their income statement via myGov.
Remittance Cycles
How often PAYG withholding must be remitted depends on the employer's annual withholding amount:
Small withholder (under $25,000 per year): Remit quarterly, with the BAS. Medium withholder ($25,000–$1 million per year): Remit monthly. Large withholder (over $1 million per year): Remit within 5 to 7 days of each pay event.
Most small business clients are small withholders — their PAYG withholding is reported and remitted on their quarterly BAS. If a client's payroll grows to the point where they cross the $25,000 threshold, the remittance cycle changes — make sure this is captured.
Common Errors and How to Catch Them
Withholding at the wrong rate. Typically happens when a new employee doesn't provide a TFN declaration and the employer withholds at a rate lower than the maximum. Check that all new employees have a TFN declaration on file.
Not withholding when no ABN is quoted. If a contractor doesn't provide an ABN, 47% withholding applies. This is missed more often than it should be — establish a practice of checking ABN status before making any contractor payment.
Incorrect super on allowances. Some allowances are included in ordinary time earnings for super purposes; others are excluded. Award-specific allowances have specific treatment under the relevant Modern Award and the SGC Act.
Year-end timing errors. Wages paid after 30 June but relating to work done before 30 June — timing of the PAYG withholding and the deductibility of the wages expense depend on when the payment is made, not when the work was done.
Director Penalty Notices: The Stakes for Non-Compliance
If an employer fails to remit PAYG withholding by the due date and does not report the liability to the ATO via STP or BAS, the ATO can issue a Director Penalty Notice (DPN) making the directors personally liable for the unpaid withholding. The DPN imposes a penalty equal to the unpaid withholding amount — and the personal liability cannot be avoided even by putting the company into administration if the liability was not reported on time.
The key safeguard: always report PAYG withholding accurately and on time, even if the business cannot pay immediately. Reporting without paying creates a liability the ATO will pursue — but it preserves the director's ability to use administration or voluntary disclosure to manage the debt. Failing to report at all removes that option.
PAYG withholding is not an area where "close enough" is acceptable. The compliance requirements are specific, the consequences of failure are severe, and the bookkeeper's role in getting it right is significant.