PAYG withholding and PAYG instalments both show up on your activity statement, both start with the same three letters, and both get confused with each other constantly. They're actually solving two different problems — one is about your employees' tax, the other is about yours.
What is the difference between PAYG withholding and PAYG instalments?
PAYG withholding is tax you take out of payments to other people — employees, directors, and some contractors — and send to the ATO on their behalf, so they're not left with a large tax bill at the end of the year. PAYG instalments work the other way: they're prepayments toward your own income tax liability as a business owner, based on the ATO's estimate of what you're likely to earn, so you're not hit with your entire year's tax bill in one go after lodging your return.
Who needs to register for PAYG withholding?
Any business paying wages to employees or directors needs to register for PAYG withholding before the first payment is made. It also applies to payments to contractors who have a voluntary withholding agreement in place, and to some payments where the payee hasn't quoted an ABN. Once registered, you withhold tax from each payment according to ATO tax tables, report it through Single Touch Payroll, and remit the withheld amounts to the ATO — usually alongside your BAS.
How do I know if I need to pay PAYG instalments?
You don't apply for PAYG instalments directly — the ATO enters you into the system automatically once your business or investment income crosses a threshold, typically identified after you lodge a tax return. You'll get a letter or notice on your next activity statement showing either an instalment rate (a percentage applied to your reported income) or a fixed instalment amount, depending on which option applies to your business.
Quarterly or annual instalments?
Most small businesses pay quarterly instalments alongside their BAS. If your GST turnover is below the relevant threshold and you're not registered for GST, you may be eligible to pay PAYG instalments annually instead, which simplifies your reporting but means a larger single payment.
What happens if I withhold too little or pay too little in instalments?
Under-withholding from employee pay isn't just a compliance risk — it usually means your staff owe more tax at year end than they expected, which creates friction even though the shortfall technically sits with the employer if withholding wasn't done correctly. Under-paying PAYG instalments doesn't attract a specific penalty, but the gap between what you've prepaid and your actual tax liability becomes due as a lump sum when you lodge, sometimes with interest if the underpayment is substantial.
Can I vary my PAYG instalment amount?
Yes, and it's worth doing if your business has had a materially better or worse year than the ATO's estimate assumes. You can vary the instalment rate or amount on your activity statement each quarter. Varying too aggressively downward without a reasonable basis can attract a penalty if it results in significant underpayment, so this is a good one to run past your accountant rather than guessing.
Getting PAYG withholding and instalments set up correctly from day one avoids nasty surprises for both you and your employees. The Metier Group's BAS agent services can handle both alongside your regular reporting — contact us to get set up correctly.