1.1 The Inspector-General of Taxation’s (IGT) review into aspects of the Pay As You Go (PAYG) instalments system was conducted largely in response to insights drawn from the complaint handling service which the IGT has been providing to the community since May 2015. There was also stakeholder support for this review to be undertaken during the consultation on the IGT 2017 work program.
1.2 It is the first time that the IGT has been able to analyse sufficient complaint investigation data to determine that a particular review was required. This is a significant development as it allows the IGT to take prompt action into targeted areas of real concern. The IGT had previously foreshadowed that, whilst consultation to develop the work program would continue, there would be increased reliance on themes emerging from the complaint handling service.
1.3 This review is targeted at the PAYG instalments system as it pertains to individual taxpayers. The terms of reference and submission guidelines were released on 29 March 20171 and submissions were received from individual taxpayers, tax practitioners and their representative bodies.
1.4 Concerns raised in complaints and submissions broadly relate to:
- taxpayer awareness and understanding of the PAYG instalments system;
- the ATO’s processes to administer the PAYG instalments system; and
- elements of the PAYG instalments framework, namely: the entry criteria, instalment calculations as well as penalties and interest for incorrectly estimating income and instalment rates.
1.5 The IGT review team has worked progressively with the ATO to distil potential areas for examination, independently considered ATO systems, processes and procedures and analysed relevant ATO statistics to develop recommendations for improvement.
1.6 The PAYG arrangements scheme, of which the PAYG instalments system is a part, aims to assist taxpayers meet their anticipated tax liabilities by making progressive payments to minimise large end-of-year tax bills whilst providing the Government with revenue during the financial year.2 The scheme requires periodic reporting and pre-payment of income taxes during the financial year.3
1.7 The PAYG arrangements scheme was implemented on 1 July 2000 to provide a single set of common machinery rules and replace 11 pre-existing reporting systems4 which were considered to have created duplicate obligations or were inefficient and outdated.5
1.8 The PAYG arrangements scheme provides both a withholding system and an instalments system. The withholding system requires a person who makes a payment to a taxpayer for work,6 such as salary or wages,7 to withhold an amount from the payment and remit it to the Commissioner of Taxation (the Commissioner). The withheld amount is then applied by the Commissioner towards the annual income tax liability of the taxpayer.8
1.9 Taxpayers who earn business or investment income, such as interest and dividends, which is not subject to withholding at source,9 are required to periodically pay instalments towards their annual income tax liability if they are so notified by the Commissioner.10 Upon entry into the PAYG instalments system, the ATO provides taxpayers with an Activity Statement setting out the taxpayer’s instalment amount which is based on their previous year’s income tax liability. Generally, instalment amounts are required to be paid on a quarterly basis directly to the Commissioner.11
1.10 The number and type of entities as well as the quantum of instalments paid from the 2013–14 to 2015–16 financial years, inclusive, are set out in Table 1.1.
1.11 Table 1.1 above shows that individuals have the greatest representation by number in the PAYG instalments system, consistently comprising over 70 per cent of all taxpayers over the 2013–14 to 2015–16 financial years. Their contribution to the total revenue has increased from 20 percent in 2013–14 to 25 per cent in 2015–16.
1.12 Importantly, other entities, such as companies, are significant contributors to revenue collections for Government as Table 1.1 demonstrates. However, the focus of this review is individual taxpayers, in line with the concerns raised with the IGT in complaints and submissions.
1.13 There are six main stages in a taxpayer’s interactions with the PAYG instalments system which are set out in the figure below.
Figure 1.1: Six stages of the PAYG instalments lifecycle
Business or investment income
1.14 Broadly, business or investment income is earned without amounts of tax being withheld at source. Examples of such income include income earned as a sole trader (sale of goods or service fees), bank interest, dividends or rental income.12 In contrast, employment income is an example where the employer withholds tax at source.
1.15 The legislative framework for the PAYG instalments system is set out in Division 45 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953). The legislation requires any person, who is provided with an instalment rate by written notice from the Commissioner, be entered into the PAYG instalments system and periodically pay instalments towards their annual income tax liability.
1.16 The criteria for receiving an instalment rate notice are determined by the ATO. Subject to a number of exemptions, for individual taxpayers, the criteria is whether the amount of gross business or investment income reported in their latest tax return equals or exceeds a certain threshold. For Australian tax residents that threshold is $4,000 whilst for non-residents, it is $1.13 The exemptions apply where:
- the tax payable on the latest notice of assessment (NOA) is less than $1,000;
- the notional tax14 is less than $500; or
- there is an entitlement to the seniors and pensioners tax offset.15
1.17 The ATO’s systems will automatically16 determine whether an individual taxpayer meets the PAYG instalments entry criteria. However, an individual may also voluntarily enter the PAYG instalments system by contacting the ATO via telephone or via the online myGov platform if they believe they will be earning business or investment income.17 Upon a taxpayer voluntarily entering into the PAYG instalments system, they may choose the quantum of their instalments.18
1.18 The ATO notifies individual taxpayers of their entry into the PAYG instalments system by way of a ‘welcome letter’.
1.19 The ATO’s ‘welcome letter’ is posted to a taxpayer’s nominated postal address registered on the ATO’s Income Tax Account (ITA) system. This address may either be the individual’s address or that of their tax agent.
1.20 Following notification to an individual taxpayer of their entry into the PAYG instalments system, the ATO issues an Activity Statement before the first instalment is due. The Activity Statement is sent to either the individual’s nominated postal address registered on the ATO’s Integrated Client Account (ICA) system, the individual’s online myGov account or to the individual’s tax or Business Activity Statement (BAS) agent via the agent’s respective Portals19 or practice management software.20 Where the Activity Statements are sent depends upon a range of circumstances which will be examined in Chapter 3.
1.21 Individual taxpayers, who have additional tax reporting obligations, such as for Goods and Services Tax (GST), are required to report their PAYG instalments on a BAS. For the purpose of this report, reference will be made to Activity Statements inclusive of those who are required to report by lodging a BAS, unless otherwise specifically mentioned.
1.22 The Activity Statement sets out the PAYG instalment amount or rate to be paid. By default, individual taxpayers are required to pay the instalment amount set out in their Activity Statement. This amount is based on their most recently assessed income tax return which is adjusted by the likely growth in Australia’s Gross Domestic Product (GDP) (GDP adjusted method).21 For the 2017–18 financial year, the GDP growth factor is 4 per cent.22
1.23 As a default position, individual taxpayers are required to report and pay instalments on a quarterly basis.23 The standard quarterly due dates for reporting24 and payment25 are set out in Table 1.2.
|PAYG instalment quarter||Period||Activity Statement due date||BAS due date|
|1||1 July to 30 September||21 October||28 October|
|2||1 October to 31 December||21 February||28 February|
|3||1 January to 31 March||21 April||28 April|
|4||1 April to 30 June||21 July||28 July|
1.24 Table 1.2 shows that PAYG instalments are generally due for payment 21 or 28 days after the relevant quarter has ended, except for the second quarter which has an additional month leeway.
1.25 Individual taxpayers may make certain elections concerning the instalments they need to pay and how often they do so via lodgment of their Activity Statement. These elections are described in the section below.
Lodging Activity Statements
1.26 The Activity Statement may issue in one of 19 different forms which depend upon the combination of the taxpayer’s obligations, such as GST, and the elections they make (see Appendix 2 for a sample Activity Statement). For example, individual taxpayers may vary their instalment calculation method or their instalment reporting/payment frequency when lodging their Activity Statement.
1.27 If taxpayers adopt the default GDP adjusted method, they can vary the amount every quarter by substituting their estimated benchmark tax26 in place of the amount determined by the Commissioner.27
1.28 Alternatively, taxpayers may elect not to use the GDP adjusted method at the start of a financial year and determine their PAYG instalments on the basis of their income earned in the current quarter multiplied by an instalment rate set by the Commissioner (instalment rate method). Again, taxpayers can vary the instalment rate calculated by the Commissioner every quarter,28 for example, where there is significant change in investment activities such as ceasing business or investment activities.29
1.29 However, if the taxpayer reduces the instalment amounts by one of the above methods but the total of the instalment amounts are found to have been understated by 15 per cent or more on or after the end of the financial year, the taxpayer may be subject to a penalty equivalent to the General Interest Charge (GIC) on the shortfall (the 15 per cent Rule).30
1.30 The due date for varying instalments aligns with the dates the Activity Statements are required to be lodged, as explained in Table 1.2. The ATO has some flexibility to vary quarterly PAYG instalment amounts where requests are received after the statutory due date but before the next Activity Statement has been generated.31
1.31 Taxpayers may also elect to report and pay instalments on an annual basis instead of quarterly. To be eligible to report and pay instalments annually, legislation requires that individual taxpayers’ notional tax, as determined by the ATO, is less than $8,000 and that they are not required to be registered for GST.32
1.32 The election to report and pay instalments annually for new entrants into the PAYG instalments system must be made before the due date of their first Activity Statement. Taxpayers already in the PAYG instalments system must make the election before the due date of the first instalment quarter being 28 October each year.33
1.33 The due date for reporting annual instalments is 21 October each year except for self-preparers who lodge their income tax return by 31 October.34 Additionally, annual payers may also be subject to GIC on any shortfall amounts as with quarterly payers.35
Processing instalment payments
1.34 The ATO operates two accounting systems, the ITA and the ICA systems, to record taxpayers’ PAYG instalment liabilities, payments and credits. The ITA system records all transactions in relation to annual income tax assessments, such as income tax liabilities, amendments and refund payments as well as the crediting of PAYG instalment liabilities in those assessments. The ICA system, on the other hand, records transactions for obligations, such as PAYG instalments, PAYG withholding and GST, which do not relate to annual income tax assessment.
1.35 Accordingly, once a taxpayer enters the PAYG instalments system, PAYG instalments liabilities and payments are recorded on the taxpayer’s ICA.36 For example, amounts due on an Activity Statement are recorded as liabilities on the taxpayer’s ICA and payments made towards those due amounts are recorded as credits on that account.
1.36 Upon lodgment of an income tax return, a credit equal to the total amount of the PAYG instalment liabilities that accrued during the financial year is posted to the individual’s ITA. As mandated by legislation, such crediting occurs regardless of whether the PAYG instalment liabilities were actually paid37 and any unpaid instalments remain as liabilities on the individual’s ICA. Further analysis of this accounting process is presented in Chapter 3.
1.37 The Commissioner automatically withdraws the instalment rate notice or exits individual taxpayers from the PAYG instalments system if, for example, the taxpayer no longer meets the entry criteria mentioned earlier in this chapter.38
1.38 Taxpayers may also make a request to exit the PAYG instalments system if their circumstances change, for example, if they have ceased earning business or investment income.39
1 Terms of reference are reproduced in Appendix 1 of this report.
2 Explanatory Memorandum, House of Representatives, A New Tax System (Taxation Laws Amendment) Bill (No. 1) 1999, p 1.
3 Taxation Administration Act 1953 sch 1 s 6-1.
4 For example, pay as you earn (PAYE), prescribed pre-payments system (PPS), provisional tax and the company superannuation fund systems: Explanatory Memorandum, House of Representatives, A New Tax System (Tax Laws Amendment) Bill (No. 1) 1999, p 1.
5 The Treasury, Submission to the Joint Committee of Public Accounts and Audit, Report 410 Tax Administration, para [7.1].
6 Explanatory Memorandum, House of Representatives, A New Tax System (Tax Laws Amendment) Bill
(No. 1) 1999, p 8.
7 The types of payments for work from which amounts must be withheld are summarised in Div 10 of Sch 1 to the Tax Administration Act 1953.
8 Taxation Administration Act 1953 sch 1 s 6-5(2).
9 Taxation Administration Act 1953 sch 1 s 45-120.
10 Taxation Administration Act 1953 sch 1 s 45-15.
11 Taxation Administration Act 1953 sch 1 s 45-1.
14 Notional tax is an estimate of the tax payable on business and/or investment income (excluding net capital gains) in the latest year for which income tax had been assessed: Taxation Administration Act 1953 sch 1 s 45-325.
15 Above n 13.
16 ATO, ‘PAYG instalments – end to end process’ (Internal ATO Document, 3 July 2017).
18 Above n 16.
21 Taxation Administration Act 1953 sch 1 ss 6-5(3), 45-112 and 45-405; Explanatory Memorandum, House of Representatives, A New Tax System (Tax Laws Amendment) Bill (No. 1) 1999, p 51.
23 Taxation Administration Act 1953 sch 1 subdivision 45-D; ATO, ‘PAYG instalments – end to end process’ (Internal ATO Document, 3 July 2017).
24 Taxation Administration Act 1953 sch 1 s 15-150(a).
25 Taxation Administration Act 1953 sch 1 s 16-75(4).
26 ‘Benchmark tax’ is an estimate of tax that will be payable for the income year, reduced by any tax attributable to any capital gains that may be included in assessable income and any credits for amounts deducted from withholding income: Tax Administration Act 1953 sch 1 s 45-415.
27 Taxation Administration Act 1953 sch 1 ss 45-412 and 45-415.
28 Taxation Administration Act 1953 sch 1 s 45-205.
30 Taxation Administration Act 1953 sch 1 ss 45-230, 45-360, 45-232 and 45-365.
31 Above n 16.
32 Tax Administration Act 1953 sch 1 s 45-140.
33 Tax Administration Act 1953 sch 1 ss 45-125 and 45-140.
35 Tax Administration Act 1953 sch 1 s 45-235.
36 Above n 16.
37 Taxation Administration Act 1953 s 45-30.
38 Above n 16.
39 For example, individual taxpayers with a myGov account linked to the ATO may request cessation of PAYG obligations online.