Chapter 4 — Elements of the PAYG instalments framework
- entry into the PAYG instalments system;
- penalties and interest for under-reporting instalment amounts; and
- the instalment rate method for calculating PAYG instalment amounts.
4.2 Stakeholders raised concerns, in complaints and in submissions to this review, regarding the ATO’s administrative criteria for automatic entry into the PAYG instalments system for individual taxpayers as well as voluntarily entering the system.
4.3 With respect to the ATO’s administrative criteria, concerns were raised that the threshold for business and investment income:
- is too low resulting in a greater number of taxpayers in the system and over collection of tax which has to be refunded later;
- does not allow for situations where there is a one-off spike in income, for example, where interest may be temporarily earned between the sale and purchase of a family home; and
- is disruptive to taxpayers who move in and out of the system due to fluctuating income from year to year, creating cash flow difficulties and impacting savings habits.
4.4 Stakeholders have expressed concerns that some taxpayers are being refused voluntary entry into the system. They consider voluntary entry to be important in assisting new businesses to manage their cash flows, particularly after their first financial year, when they are required to pay their annual income tax and, shortly afterward, their first PAYG instalment in respect of their next year’s income tax liability.
PAYG instalments entry threshold
4.5 As stated in Chapter 1, subject to limited exceptions, taxpayers who have reported $4,000 or more of business or investment income in their most recent annual tax return, are automatically placed into the PAYG instalments system.97
4.6 Since the inception of the PAYG instalments system on 1 July 2000 until 30 June 2014, the amount of the threshold criteria has doubled from its then base of $2,000. The threshold for two of the exemptions referred to in Chapter 1 have similarly doubled.98
4.7 The ATO’s tax statistics demonstrate that individual taxpayers comprised over 70 per cent of all taxpayers in the PAYG instalments system and are contributing an increasing amount towards total revenue collected through the PAYG instalments system (from 20 per cent in 2013–14 to 25 per cent in 2015–16).
4.8 The ATO statistics comparing the payment of PAYG instalments to their notional tax amount for the 2015–16 financial year is set out in Table 4.1 below.
|PAYG instalments compared to notional tax (%)||Number of taxpayers|
|51 to 60%||50,699|
|61 to 70%||55,301|
|71 to 80%||61,855|
|81 to 90%||69,610|
|91 to 100%||79,333|
|101 to 105%||44,419|
|106 to 110%||39,627|
|111 to 120%||62,106|
Note: The above statistics only include those individuals where a comparison can be made between the amount reported in their Activity Statements during the year and the calculation of their notional tax amount upon the lodgment of their income tax return. For example, individuals who exited the system part way through the year are not included.
4.9 Table 4.1 shows 991,138 individual taxpayers remained in the PAYG instalments system by the end of the 2015–16 financial year.99 Of these individual taxpayers, 423,871 or 42.8 per cent, paid PAYG instalment amounts greater than their notional tax amount during the 2015–16 financial year. However, 567,267 or 57.2 per cent of individuals had paid less than their notional tax amount for the year. It also appears that over 28 per cent of individuals (277,719) estimated a higher PAYG instalment liability by more than 20 per cent of their end of year tax assessment. Conversely, almost 25 per cent of individuals reported instalments lower than their notional tax amount by more than 50 per cent.
4.10 The Joint Committee of Public Accountants and Audit (JCPAA) in their 2008 report100 considered that some over collection of tax via the PAYG instalments system, was appropriate. The main reasons for their view was that it was unreasonable to expect taxpayers to focus on their tax position and adjust their spending throughout the year, eliminating over collection in aggregate would result in more taxpayers in debt which would cause payment difficulties and that taxpayers prefer to receive tax refunds.101
4.11 It is worth considering the effect of increasing the threshold criteria for entry into the system on government revenue and the number of individuals that may be removed from the system. Table 4.2 includes some data in this regard.
|Threshold||Number of individuals removed||PAYG instalment amounts reduced|
|$4,000 to <$5,000||14,653||$24,072,282|
|$5,000 to <$6,000||14,585||$24,717,354|
|$6,000 to <$7,000||14,029||$31,463,097|
|$7,000 to <$8,000||13,649||$27,002,991|
4.12 Table 4.2 demonstrates that if the ATO increased the business and investment income threshold to $5,000, $6,000, $7,000 or $8,000, it would remove 14,653, 29,238, 43,267 and 56,916 individual taxpayers from the PAYG instalments system respectively. This is compared to the 1,447,035 total individuals in the system during the 2015–16 financial year.102
4.13 It is also important to note the corresponding impact to revenue would be $24,072,282, $48,789,636, $80,252,733 and $107,255,724 respectively. This is compared to the $21 billion collected from all individuals in the PAYG instalments system for the 2015–16 financial year.103 It should also be noted that such amounts are likely to be recovered once tax returns for the relevant period are lodged.
4.14 The ATO statistics in Table 4.3 presents a sample of individuals who entered the PAYG instalments system during the period between 1 July 2016 and 31 May 2017 and how frequently they re-entered the system dating back to 1 July 2012.
|Market Segment||Entered x1||Entered x2||Entered x3||Entered x4||Entered >4||Total|
– non business
4.15 Table 4.3 only considers a sample of individual taxpayers who were in the PAYG instalments system during a portion of the 2016–17 year, specifically those who entered during the period 1 July 2016 to 31 May 2017. It demonstrates that of these taxpayers, 77,190 individuals were entered into the system for a second time, 5,788 for a third time and 44 for four or more times, dating back to 1 July 2012.
PAYG instalments voluntary entry
4.16 Individual taxpayers can voluntarily enter into the PAYG instalments system by telephone or via their online myGov account.104 Currently, there is no ATO commitment to provide additional functionality in the tax and BAS agent Portals to allow taxpayers’ representatives to voluntarily enter their clients into the PAYG instalments system.
4.17 Table 2.4 shows the number of individuals that have voluntarily entered into the PAYG instalments system from 1 July 2013 to 21 June 2017, by financial year.
|Number of individuals||2,702||3,346||4,799||5,447||9,518|
4.18 As depicted above, the number of individuals voluntarily entering the PAYG instalments system has steadily increased over the last 5 financial years, from 2,702 in 2012–13 to 9,518 in 2016–17. It should be noted that the largest increase was from the 2015–16 financial year (5,447) to the 2016–17 financial year (9,518).
4.19 The ATO also promotes voluntary entry by publishing information and introductory videos on the ATO’s website.
PAYG instalments entry threshold
4.20 The PAYG instalments system aims to assist taxpayers with business or investment income to save and progressively pre-pay amounts of tax towards anticipated tax liabilities that arise at the end of the financial year. It also provides Government with more even revenue collection throughout the financial year.
4.21 Whilst the IGT acknowledges the importance of the role of the PAYG instalments system in maintaining an effective tax collection strategy, it is important to ensure that it continues to operate efficiently with minimal adverse impact on affected taxpayers. Therefore, it is important to monitor the entry and exit criteria such that the taxpayers that remain in the system are the very ones that the relevant legislation seeks to assist.
4.22 The ATO’s PAYG instalments entry criteria were updated once in the last 17 years of operation. The IGT is of the view that, if the ATO were not to amend their entry criteria periodically, the efficient administration of the system may be compromised and some taxpayers adversely affected.
4.23 The ATO’s data shows that increasing the threshold criteria to say $8,000 for business or investment income, will allow almost 57,000 individuals to exit the system with a resulting reduction of $107 million in instalments collection. However, such amounts are likely to be recovered a short time later when the relevant tax returns are lodged. In any event, it is a relatively small amount when compared to the $21 billion which is the total amount of instalments collected from individual taxpayers.
4.24 Increasing the threshold would also have compliance cost savings to those individuals excluded from the system and administrative costs for the ATO. Whilst compliance and administrative cost savings data is unavailable, increasing the threshold to $8,000 would completely remove the need for annual reporting. Annual reporting has a short timing benefit to government as the due date to pay annual instalments is 21 October compared to annual income tax payment which is due 21 days after the lodgment due date (generally 31 October for self-preparers).105
4.25 On the above basis, the IGT believes that the ATO should periodically review the threshold criteria taking into account the broader economic environment such as interest rates and credit availability.
4.26 The ATO’s PAYG instalments entry criteria also does not account for situations where a taxpayer may experience a temporary positive or negative spike in income. This is because a taxpayer’s entry into the system is only based on their most recently assessed annual income tax return. One option suggested by some stakeholders has been for taxpayers to indicate in their annual tax return that they have an increased one-off spike in business or investment income, thereby proactively preventing their entry into the system. However, other stakeholders observed, and ATO research suggests,106 that many individuals do not have an awareness of the PAYG instalments system, particularly where they have not interacted with it previously. Therefore, such an option may not be effective.
4.27 Another option is to make taxpayers aware of the circumstances in which they may exit the PAYG instalments system. Currently, the ATO’s welcome letter does not explain the circumstances in which taxpayers are eligible to exit the system. Chapter 2 of this report deals with the updating of the ATO’s welcome letter and website to address this concern. Clearer guidance would better inform taxpayers and enable them to request an exit where there is a one-off spike in income.
4. 28 Furthermore, providing tax and BAS agents with functionality to enter or remove their clients would also make it easier to exclude taxpayers who should not be in the system. In this respect, the IGT notes that the ATO is currently transitioning to its Practitioner Lodgment Service (PLS) whereby tax representatives use Standard Business Reporting (SBR) enabled software to interact with ATO systems. As part of this process, it would be beneficial for the ATO to seek additional practice management software functionality that allows tax and BAS agents to voluntarily enter their clients into or remove them from the PAYG instalments system.
4.29 The ATO’s entry criteria for the system also cannot account for situations where individuals have fluctuating business or investment income from year-to-year, for the same reasons as for one-off spikes in income. The ATO’s statistics in Table 4.3, show that for the 377,288 taxpayers entering into the system at some time for a selected 11 month period, 83,022 (or 22 per cent) of them had previously been in the system within approximately the last 5 years. This suggests that many taxpayers may experience disruptions caused by entry, exit and re-entry, into the PAYG instalments system.
4.30 For example, taxpayers, who held investment properties in a particular year where significant expenditure was incurred, would be required to report PAYG instalment Activity Statements in that year but would then be removed from the system in the following year. However, it would have been appropriate for them to remain in the PAYG instalments system as their expenditure had ceased and they would earn investment income greater than the entry criteria. This example illustrates the frustration experienced by taxpayers who regularly enter and exit the PAYG instalments system because the instalment amounts are calculated on the basis of information reported in their previous tax return.
4.31 The ATO could use a rolling average of income tax assessments, say for the previous three financial years, to determine whether a taxpayer should be entered into or exited from the PAYG instalments system. Such an approach could potentially avoid unnecessary system entry or exit unless the spikes in income are particularly significant. However, averaging the entry criteria could lead to greater concern amongst individuals who do not understand why they have been entered into the PAYG instalments system. Furthermore, averaging the threshold would add further complexity to the entry criteria, particularly as some aspects would be difficult to average such as the eligibility for the senior tax offset. Averaging would also delay system entry and exit, creating additional issues such as cash flow difficulties for new businesses.
4.32 Another option to minimise the disruption caused for individuals who continually enter and exit the PAYG instalments system, is for the ATO to keep individuals in the system even if they no longer meet the automatic entry requirements and instead notify them of their ability to exit the system. However, this would increase compliance costs as it would require taxpayers to request exit from the system.
4.33 In order to achieve an appropriate balance between the competing interests, the IGT believes that taxpayers, who are to be automatically exited from the system, should be alerted of the option to voluntarily remain in the system. Such an approach accords with the existing voluntary entry process and assist individual taxpayers in improving their financial management in terms of savings and consistently meeting their tax obligations.
4.34 In its exit letter to taxpayers, who no longer meet the automatic entry criteria, the ATO briefly mentions that they may voluntarily remain in the system. However, the low number of taxpayers who do so indicates that the matter may need to be raised more prominently, including stating the associated benefits.
4.35 Voluntary entry into the PAYG instalments system provides individuals with an important means to better manage their cash flows and future taxation liabilities. Whilst statistics provided in Table 4.4 illustrate voluntary entrants are increasing, the IGT is aware of some cases where the ATO has not accepted pre-payment of their anticipated liabilities.
4.36 Some stakeholders have suggested that sole traders and small businesses should automatically be placed into the PAYG instalments system once they receive an ABN. However, the IGT considers that such a requirement may penalise those who have good saving habits. There may also be difficulties with estimating cash flows at the time of applying for an ABN. It has also been suggested that there should be a smaller PAYG instalment rate or a gradual part payment system to assist first year businesses identified by the ABN registration process. However, given the difficulties with estimation of income, these options are unlikely to be helpful in a practical sense.
4.37 The best option for helping new businesses may be to inform them and their trusted advisors about the system, particularly their ability to voluntarily enter into the system, and make it as easy as possible for them or their advisors to exercise such choices.
The IGT recommends that the ATO improve its monitoring of the entry and exit criteria of the PAYG instalments system by:
- periodically reviewing, at least every three years, the threshold entry criteria;
- better informing those no longer meeting the entry criteria that they may choose to voluntarily remain in the system; and
- seeking to provide additional functionality, in its new Practitioner Lodgment Service, to allow BAS and tax agents to voluntarily enter or exit their clients into or out of the system.
The ATO will ensure that the existing process to review the PAYG instalments entry/exit thresholds will occur at least every three years. Treasury will be contacted where changes are recommended.
The ATO already provides this information in the taxpayer’s PAYG instalments exit letter. However, we will consider using additional methods, such as behavioural insights, to bring this to the taxpayer’s attention.
The ATO plans to replicate the functionality in ATO Online to enable tax and BAS agents to voluntarily enter and exit their clients from PAYG instalments. These system changes will depend on funding and the prioritisation process.
4.38 As mentioned in Chapter 1, the 15 per cent Rule allows the ATO to apply a penalty equivalent to accrued GIC where varying instalments resulted in less than 85 per cent of the notional tax amount which should have been paid.107 Some stakeholders have expressed concern that the safe harbour offered by the 15 per cent Rule is too low. They explained that this causes taxpayer apprehension against varying their instalments as they may be subject to penalties. Accordingly, taxpayers may overestimate their instalments which unnecessarily impacts their cash flows. These stakeholders are of the view that more leeway is required given the difficulty for taxpayers to accurately estimate their future tax liabilities.
4.39 On the other hand, some stakeholders consider that the ATO should take a more proactive approach to caution taxpayers who regularly vary their instalments to nil and have a large tax bill upon assessment of their annual tax return.
4.40 Although the ATO does not have an automated process in place to impose the 15 per cent Rule, it publicly warns taxpayers and their representatives that it is reasonable for them to assume that a penalty will apply if instalment amounts are underestimated. However, since the introduction of PAYG instalments, the ATO has advised the IGT that due to the complexity of the calculation, there have been very few cases where the penalty has been applied and in almost all cases where the penalty was imposed it was subsequently remitted upon review.
4.41 Pursuant to Part 4-25, of Schedule 1 to the TAA 1953, the ATO may also apply an administrative penalty where it is determined that an individual has knowingly made a false or misleading statement which results in a shortfall amount. The result may be a penalty equivalent to 25, 50 or 75 per cent of the shortfall amount depending on the behaviour which gave rise to the shortfall. Since the introduction of PAYG instalments, the ATO has advised that there have been no cases where a penalty for false and misleading statement penalty has been applied.
4.42 During this review, the compliance area of the ATO’s PAYG instalments team has developed a strategy for educating taxpayers requiring assistance to meet their obligations, such as those who persistently vary their instalments to nil and have a large income tax bill on assessment. It is proposed that where such behaviour is not addressed through education, stronger compliance action will be considered such as the imposition of a penalty.108
4.43 Despite warnings, a lack of ATO action to enforce the 15 per cent Rule may have led to a perception amongst certain taxpayers that underestimation of PAYG instalments has little or no consequence. Indeed, some of these taxpayers may have acted on such perception. As noted earlier, the ATO statistics demonstrate that 25 per cent of individuals are underestimating their instalments amounts by 50 per cent or more.
4.44 Conversely 28 per cent of individuals pay instalment amounts greater than their notional tax assessment by more than 20 per cent. As some stakeholders have suggested, these taxpayers may be overestimating due to the combined complexity of calculation, low safe harbour provided by the 15 per cent Rule and fear of penalty.
4.45 Accordingly, whilst at present, the net position to revenue may not be significantly affected, there may be an uneven playing field with some knowingly underestimating whilst others are overestimating their PAYG instalment amounts. Furthermore, continued inaction to enforce penalties may lead to a broader trend of non-compliance with the PAYG instalments system.
4.46 It is understandable that taxpayers may experience difficulties with estimating future liabilities, for example, where an individual is earning investment income but only receives annual statements from the relevant financial institution. Furthermore, the ATO may also face challenges in imposing the 15 per cent Rule. Currently, it would have to manually compare instalment amounts reported in Activity Statements with income reported in income tax returns.
4.77 During the course of this review, the ATO has developed a risk treatment strategy to educate and warn individuals who repeatedly or excessively underestimate their PAYG instalment amounts and where appropriate impose penalties. The IGT supports such a strategy and believes that the ATO should refine and adopt it as soon as practicable. This strategy should also be widely publicised to influence taxpayer behaviour by, for example, highlighting it in a brochure that taxpayers may receive upon entry into the system as is discussed in Chapter 2. Additionally, the ATO should also consider reporting its enforcement activities, including the number and quantum of penalties imposed, in its Annual Report or website.
The IGT recommends the ATO:
- educate and warn taxpayers of the risk of underestimation of PAYG instalment amounts particularly where repeated and/or excessive underestimations occur;
- enforce penalties in appropriate circumstances where such taxpayers have repeatedly not adhered to warnings; and
- publish statistics on its enforcement activities including the number and quantum of penalties imposed.
An education campaign commenced during the period of the review.
The ATO agrees that if after education and leverage activities taxpayers continue to underestimate their instalment income or excessively vary their instalment rate, then the ATO may impose penalties or interest in the future. This could start as early as 2018.
As part of the ATO’s treatment strategy, the ATO will maintain, report and publish these statistics.
4.48 Stakeholders have expressed concern that statutory income, such as Employee Share Scheme (ESS) income derived under a deferred scheme,109 are included in the calculation of PAYG instalments which results in individuals receiving an instalment rate significantly greater than their marginal income tax rate.
4.49 Taxpayers who elect to pay instalments using the rate method have explained that they must manually exclude the income in each reporting period causing unnecessary compliance costs. This is exacerbated when the taxpayer is required to continue this approach in subsequent financial years.
4.50 Individuals may choose between the GDP adjusted amount method and instalment rate method when reporting their PAYG instalment amounts. The instalment rate is calculated as:
[ Notional tax/Base assessment instalment income (BAII) ] x 100 =
4.51 Notional tax is the tax attributable to the taxpayer’s business or investment income for the most recent assessment, based on current income tax rates.111 BAII is the amount of instalment income in the most recent assessment.112 Instalment income in this context is defined to only include income according to ordinary concepts.113
4.52 Accordingly, statutory income is included in the numerator but not in the denominator of the equation. As a result, statutory income can produce an instalment rate higher than the top marginal tax rate and in some cases may be 1,000 per cent or more. This arises where very little ordinary income is earned but large amounts of statutory income are derived resulting in instalment amounts significantly higher than the annual tax assessment. Taxpayers who pay using the GDP adjusted amount method do not suffer the above outcome as it is purely based on the GDP adjusted notional tax.
4.53 Approximately 14,000 taxpayers, who use the instalment rate method, are issued with a rate higher than their marginal tax rate each year. The ATO provides guidance to such taxpayers each year to mitigate the confusion caused.114
4.54 In 2015, the ATO considered proposing a change to the current legislation to avoid high rates by aligning the definition of the two different types of income used in the equation.115 However, as an alternative, the Commissioner has committed to exercising his general power of administration to cap the adjusted rate to 55 per cent for individuals from 1 July 2017 onwards.116 The 55 per cent rate was chosen as it takes into consideration the highest marginal tax rate for individuals, plus the Medicare levy and the Higher Education Loan Program (HELP) debt rate. The ATO’s system will automatically cap the rate, however, should individual taxpayers disagree with the rate, they may vary it.117
4.55 The instalment rate method is preferred by some taxpayers as it is based on the income derived in the current period and may provide a more accurate estimate. However, as outlined above, it may result in excessively high instalment amounts becoming payable. Such amounts may be varied but it does involve an additional compliance burden. The ATO has sought to address the issue by capping the maximum rate that may be applied effective from 1 July 2017. Accordingly, it is too early to determine its effectiveness. If it proves ineffective, the IGT is of the view that a legislative change should be considered.
97 Above n 13.
98 Bruce Billson MP, Minister for Small Business, ‘Changes to tax system drives $56m in red-tape savings for small business’ (Media Release, Nat 2014/37, 20 June 2014).
99 It is noted that these statistics do not match the statistics in Table 1.1.
100 Joint Committee of Public Accounts and Audit, Parliament of Australia, Report 410—Tax Administration (2008).
101 Ibid pp 177–179.
102 ATO, ‘Taxation statistics 2014–15’ (20 April 2017) <www.ato.gov.au >.
105 Taxpayers who lodge their annual income tax return with the assistance of a tax agent may be eligible for a deferred lodgement due date: ATO, Lodgment obligations, due dates and deferrals, PS LA 2011/15,
30 June 2017.
106 Above n 40, p 10.
107 Taxation Administration Act 1953 subdiv 45-G.
108 ATO, ‘Treatment strategy for excessive variation and understatement of PAYG instalment income’ (Internal ATO document, 16 March 2017); ATO, ‘Executive Minute – Endorsement of treatment strategy to address excessive variations and understatement of instalment income’ (Internal ATO document, 16 March 2017).
109 A deferred scheme is where shares will be received in a later income year.
110 Taxation Administration Act 1953 sch 1 s 45 -320.
111 Taxation Administration Act 1953 sch 1 s 45 -325.
112 Taxation Administration Act 1953 s 45-320.
113 Taxation Administration Act 1953 s 45-120(1).
114 ATO, ‘Advocacy Alert – Pay As You Go (PAYG) Instalments – High Instalment Rates’ (Internal ATO document, 8 May 2015).
116 ATO, ‘Executive Minute, Endorsement of Administrative solution to high instalment rates’ (ATO Internal document, 4 November 2016).