Pay as you go (PAYG)

Definition

Pay as you go (PAYG) is a system used in Australia to collect income tax from individuals and businesses as they earn income throughout the financial year, rather than in a lump sum at the end of the year. 

What is pay as you go?

Pay as you go ensures that taxpayers meet their tax obligations progressively as they earn income, reducing the likelihood of large tax bills at the end of the financial year. PAYG applies to various forms of income, including salary and wages, business income, investment income, and certain government payments.

For employees, PAYG withholding requires employers to deduct income tax from their employees’ wages or salaries before paying them. The amount withheld is based on the employee’s total earnings and tax file number declaration. Employers then pay the withheld tax to the Australian Taxation Office (ATO) on behalf of their employees.

Businesses also use the PAYG system to meet their tax obligations. In addition to withholding tax from employees’ wages, businesses may need to make PAYG instalments towards their own income tax liability and report and pay PAYG withholding tax on payments made to suppliers, contractors, and other entities.

At the end of the financial year, employers provide PAYG payment summaries to their employees, summarising the income earned and tax withheld during the year. These summaries are used by individuals to complete their income tax returns and reconcile their tax liabilities with the ATO.

Example of pay as you go

ABC Pty Ltd is required to comply with the PAYG system for taxes. It calculates income tax from employees’ wages each pay cycle, deducts it, and sends it to the ATO.

In addition to PAYG withholding for employees, ABC Pty Ltd pays PAYG instalments to the ATO throughout the year to prepay its expected income tax. These payments are based on last year’s income, adjusted for changes.

At year-end, ABC Pty Ltd reconciles PAYG instalments with actual tax liability. Any inconsistencies are adjusted. The company issues PAYG payment summaries to employees for tax return assistance.