The pay as you go system (PAYG) is a method of tax collection that was introduced in the round of tax reforms that included the introduction of the GST. PAYG replaces the old pay as you earn (PAYE) system and withholding tax from 1 July 2000.

PAYG is a single integrated system for reporting and paying tax on business and investment income and for withholding amounts from payments made to others.

PAYG is also used to collect the Medicare levy and HECS debts.

PAYG withholding

Withholding is the process by which payers deduct amounts from payments to others and remit these amounts directly to the ATO. Businesses that pay salaries and wages withhold tax from those salary and wage payments to employees and remit the withheld amounts to the ATO. Trustees of superannuation funds use the same process when they pay lump sum or pension benefits.

PAYG installments

Individuals who are Australian residents will generally be notified by the ATO of an installment rate if they have base assessment installment income of $1,000 or more and are not entitled to the pensioner rebate or the low income aged person's rebate.

The same thing applies to non-residents except the base threshold is only $1.

You don't need to pay PAYG installments if business and investment earnings are less than $1,000 on business and investment income, excluding salary and wages. You are also exempt if you receive the pensioner rebate or low income aged person's rebate.

PAYG does not replace the annual tax return, you still have to put one in. PAYG is usually paid quarterly but you can elect to pay installments annually if the taxpayers notional tax is less than $8,000 and the taxpayer is not registered for GST. This applies to partnerships and certain other entities as well as individuals.

For individuals, annual installments are due no earlier than 31 March 2002. From 2003 onward, annual payments will be due on 28 October following the income year.

Quarterly installments are due on 28 October, 28 February, 28 April and 28 July.

PAYG and individuals with investment income

If the ATO notify you that you are required to pay PAYG installments on your investment income, you are faced with the same sorts of choices that affect a contractor, namely which method of PAYG calculation to use.

If your tax exceeds $8,000 you will need to pay PAYG quarterly.

Investment income includes rent, interest, dividends, annuity income, superannuation pensions, trust income, royalties and partnership income.

If, for example, your investment portfolio was your only source of income and you paid tax at an average rate of 16% last year, this is the rate at which you would pay tax this year. If you had other salary income then your employer would already be deducting PAYG to take into account your investment income because the rate of PAYG advised by the ATO would take into account your income from last year.

You can have the PAYG rate adjusted by making a declaration to the ATO that your income will be different from last year. For example if you had just bought a negatively geared investment of some sort and expected a reduction in your taxable income you can let the ATO know about this. The form for giving this notice is called the section 221D variation form, this is available from the ATO or from their web site.