Employers have deducted tax from the weekly or fortnightly pay of wage and salary earners on behalf of the ATO since World War II through the pay as you earn (PAYE) system.

A new system for non-wage and salary earners called pay as you go (PAYG), which incorporates the PAYE system, was introduced in 2000. This system is tied in to the collection arrangements for goods and services tax (GST) and to the withholding system for business payments to people who do not have Australian business numbers).

The new system operates in much the same way as the old provisional tax system (see box), but now includes companies. The main change is the broadening of withholding tax provisions beyond taxpayers subject to PAYE deductions.

The prescribed payments system, another withholding system that used to apply to contractors in certain industries, has also been incorporated into the new system.

Provisional tax

Before 2000/01 self-employed people and those with investment income were not generally subject to PAYE withholding, but had to pay provisional tax — an amount calculated on the previous year’s income plus an ‘uplift’ factor, which was payable by instalments. Thus no tax was payable in the first year of operation, but in the second year the taxpayer received two demands, one for the current and one for the previous year.

As the threshold for provisional tax was only $1000, even low income people with non-wage and salary income could be affected. A person could declare that this year’s income would be less than last year’s and have the tax reduced, but there were penalties for incorrect declarations, even if they were made in good faith.

How PAYG instalments are collected

Under PAYG, the ATO issues an instalment rate to non-wage or salary taxpayers based on the previous year’s income, so a taxpayer starting in business will not get an instalment rate until after their first tax return is assessed.

This creates the same problem as the old system — amounts for the previous and current year falling due at the same time — but there is provision for a new business to make voluntary payments before an instalment rate is issued.

How the rate is assessed

The ATO assumes that income earned in the current year will be the same as that earned in the previous year, plus an uplift factor based on any increase in GDP (gross domestic product), and assesses the taxpayer accordingly.

When the tax is payable

If non-wage or salary income exceeds $8000, instalments are calculated quarterly (30 September, 31 December, 31 March and 30 June) and are normally payable 21 days after the end of the quarter.

If income is expected to decrease

If the non-wage income will not recur or will be less in the current year, a person paying quarterly can vary their instalment rate by notifying the ATO that they wish to estimate their tax (called a benchmark tax amount). The ATO then advises the appropriate instalment rate. This can be done each quarter, but there are penalties if the instalment turns out to be too low — so it is important not to underestimate future income.

If income is expected to increase

There is no need to apply to increase the instalment amount even if it is expected that non- wage income will increase in the current year.

When PAYG tax can be paid annually

If the notional income (estimated income for the current year as notified by the ATO) is less than $8000 and the taxpayer is not registered or required to be registered for GST, the tax can be paid annually. The due date for individuals was generally 31 March of the income year (the old provisional tax deadline), but for 2002/03 and onwards it is 21 October, after the income year.

Self-employed people in this situation should put money aside for tax as they earn it.

How much?

The amount of PAYG tax payable depends on many factors. The table below is a guide.

Tax rates 2003/04:

Taxable income Tax payable

$0 $6,000 Nil

$6,001 $21,600 17c for each $1 over $6,000

$21,601 - $52,000 $2,652 plus 30c for each $1 over $21,600

$52,001 $62,500 $11,772 plus 42c for each $1 over $52,000

Over $62,500 $16,182 plus 47c for each $1 over $62,500

The Medicare levy of 1.5% must be added to these amounts. Any tax offsets should be subtracted from the tax figure calculated.

Pensioners and PAYG

Pensioners receiving income up to the limits prescribed for the pensioner tax offset are exempt from paying PAYG tax, even if they are also receiving other non-wage income. The taxable income thresholds for offsets in 2002/03 were:

PAYG withholding

Tax is withheld from payments to people who do not quote an Australian business number.

It is deducted from salary, wages and related payments at scheduled rates for employees who provide their tax file number to their employer.

Investors must quote a tax file number to avoid having tax withheld at the top rate (48.5%).

Tax must also be withheld at the top rate from payments for supplies as defined in the GST legislation if an Australian business number is not quoted. It may be worthwhile for someone running a small business with a turnover below the GST threshold of $50,000 to get an Australian business number and go through the exercise of lodging business activity statements (see below) to preserve cash flow. The tax instalments required are calculated on the rate on last year’s income, which may be considerably less than the top rate.