You’ve just received a BAS notice telling you that you owe the ATO several thousand dollars in PAYG instalments — but your income is down this year. Do you really have to pay the full amount?

This is one of the most common questions Mina hears from Melbourne business owners. PAYG instalments can feel like an unwelcome surprise — especially when cash flow is already tight. But here’s the good news: you have more control over the amount than you probably realise.

By the end of this article, you’ll understand exactly what PAYG instalments are, when and why they apply, how the ATO calculates the amount, and — most importantly — how to vary the amount down if your income drops. Let’s get into it.

What Are PAYG Instalments?

PAYG instalments (Pay As You Go instalments) are a system for prepaying your expected income tax throughout the year, rather than being hit with one large bill at tax time. The idea is simple: instead of owing the ATO $40,000 in a lump sum when you lodge your return, you pay in quarterly (or monthly) chunks across the financial year.

PAYG instalments cover income tax on business income, investment income (such as rental income and dividends), and income from other sources — but not wages or salary, which are handled separately through PAYG withholding by your employer. Your employer super guarantee (SG) obligations are also separate — the SG rate rose to 12% from 1 July 2025. See our Super Guarantee rate 2025–26 guide for a full compliance breakdown.

The system is administered by the ATO and is separate from GST. Both are typically reported and paid through your Business Activity Statement (BAS), but they’re calculated and tracked independently.

You can read the ATO’s full overview of PAYG instalments for businesses.

Who Has to Pay PAYG Instalments?

The ATO automatically enters you into the PAYG instalment system when your income exceeds certain thresholds. You’ll receive a letter notifying you — usually after you lodge a tax return that shows significant income. The main triggers are:

• Your notional tax (estimated tax liability) is $500 or more
• Your total business or investment income is $4,000 or more
• Your tax payable is more than $1,000

In practice, most sole traders, company directors, and investors with gross business or investment income over around $75,000 will find themselves in the system. Companies pay PAYG instalments based on their own tax liability — it’s not just an individual-level obligation.

Once you’re in the system, you stay in it until you request to exit (more on that below). The obligation applies regardless of your business structure — sole trader, company, trust, or partnership — as long as you meet the thresholds.

How Does the ATO Calculate Your Instalment Amount?

The ATO uses your most recent tax return to estimate what you’ll owe this year. There are two methods for calculating your instalment obligation.

Method 1: Instalment Amount (Option T7)

The ATO calculates a fixed dollar amount for each quarter, based on your previous year’s tax. You simply pay that amount — no calculation required on your end. This is the most common method for sole traders and small businesses.

Method 2: Instalment Rate (Option T8)

The ATO provides a PAYG instalment rate (expressed as a percentage). You multiply that rate by your actual business or investment income for the quarter and pay that amount. This method automatically adjusts for fluctuations in income, which can be helpful if your revenue is uneven across quarters.

Worked Example

Say your business earned $300,000 in the previous financial year, and your income tax liability for that year was $80,000. The ATO divides that liability across four quarters, so your instalment would be $20,000 per quarter.

If instead you’re on the rate method and the ATO assigns you a rate of 6%, and in Q1 your business income is $75,000 — your instalment for that quarter is $4,500.

Both methods are an estimate of what your tax will be. They can be varied — and that’s exactly what most business owners should consider when income shifts.

When Are PAYG Instalments Due?

For most businesses, PAYG instalments are paid quarterly alongside your BAS. The standard quarterly due dates are:

• Q1 (July–September): due 28 October
• Q2 (October–December): due 28 February
• Q3 (January–March): due 28 April
• Q4 (April–June): due 28 July

Large businesses (generally those with a quarterly GST turnover exceeding $20 million) report and pay monthly rather than quarterly. If you use a registered BAS agent, you may also benefit from extended lodgement deadlines — check our BAS and tax lodgement dates guide for the full schedule.

How to Vary Your PAYG Instalment

This is the section most business owners need to read carefully — because varying your PAYG instalment is one of the most effective (and underused) cash flow tools available to you.

You can vary your instalment amount up or down at any time. If your current year income is tracking lower than last year — due to a slow period, a lost contract, reduced hours, or any other reason — you don’t have to keep paying based on your previous year’s higher income.

How the Variation Process Works

When you lodge your BAS, you’ll see a field labelled T1 — PAYG instalment amount (if you’re on the amount method) or T8 — PAYG instalment rate (if you’re on the rate method). To vary your instalment, you:

1. Estimate your total income and tax liability for the full current financial year
2. Calculate what your quarterly instalment should be based on that estimate
3. Enter your varied amount (or varied rate) in the T1 or T8 field on your BAS
4. Pay the varied amount instead of the ATO’s pre-filled figure

You’ll also need to complete the T4 — reason for variation field, where you select the reason (such as “income will be lower than last year”).

The 15% Safe Harbour Rule — Read This Before Varying Down

Here’s the critical warning: if you vary your instalment down and your actual tax liability at year-end turns out to be more than 15% higher than the varied amount you paid in total, the ATO can charge a shortfall interest charge (SIC) on the underpaid amount. This is charged at the base interest rate plus a penalty component.

In plain terms: vary conservatively. Don’t vary down to $0 if you think income might recover in Q3 or Q4. Estimate your full-year income as accurately as possible and base your variation on that estimate, leaving a buffer.

The ATO’s guidance on varying your PAYG instalments has full details on the interest charge rules.

Worked Example: Income Down 30%

Last year your business earned $300,000 and your tax liability was $80,000 — so the ATO set your quarterly instalment at $20,000. But this year, a key client left in Q1 and your projected income has dropped to around $210,000 — a fall of 30%.

Based on $210,000 income, your estimated tax liability is approximately $54,000 (using the same effective tax rate). Divided across four quarters, your varied instalment should be around $13,500 per quarter — down from $20,000.

You’d enter $13,500 in the T1 field on your BAS, select the appropriate reason in T4, and pay the varied amount. At year-end, if your income lands at $210,000 as expected, there’s no shortfall and no penalty interest.

If income recovers and you end up earning $240,000 instead, your extra tax payable at lodgement time would be relatively small — and provided it’s within 15% of what you varied to, you won’t face any interest charges. If you’re unsure where to draw the line, this is exactly the kind of scenario where speaking with a tax planning specialist before lodging your BAS can save you real money.

What Happens at Tax Time?

When you lodge your annual income tax return, all the PAYG instalments you’ve paid throughout the year are credited against your actual tax liability. The ATO squares up the account:

• If you paid too much: you receive a refund (or credit against other tax debts).
• If you paid too little: you pay the balance owing when your return is assessed.

This is why getting the variation right matters so much. If you don’t vary down when income drops, you’re essentially giving the ATO an interest-free loan for the year — money that could have been working in your business. Conversely, if you vary too aggressively and underpay by more than the safe harbour amount, you’ll face penalty interest on top of the shortfall.

A well-structured tax planning strategy should include a review of your PAYG instalment position at least twice a year — ideally at Q1 and Q3 — to make sure your payments are tracking with actual income.

Common PAYG Instalment Mistakes

In practice, Mina sees the same mistakes come up again and again with business owners:

• Paying the ATO’s pre-filled amount without reviewing it. Many business owners just accept the ATO’s figure and pay it — even when income has dropped significantly. Always review the instalment against your current year trading before lodging.
• Not realising you can exit the system. If your income has dropped below the PAYG threshold permanently — for example, because you sold a business or significantly scaled back — you can request to exit the PAYG instalment system. You can do this through your myGov account or through a registered tax agent.
• Forgetting to factor instalments into cash flow planning. PAYG instalments are a significant outgoing — potentially $20,000 or more per quarter for an established business. Not accounting for them in your cash flow forecast can leave you scrambling when the BAS is due.
• Varying down without a proper income estimate. Varying your instalment based on a rough gut feel, rather than an actual projection, is how you end up with a shortfall and penalty interest at year-end.

PAYG Instalments — Frequently Asked Questions

Frequently Asked Questions

This article contains general advice only and does not take into account your specific circumstances. Please speak with a qualified accountant or tax adviser before making financial decisions.

Managing instalments well is part of broader tax planning in Melbourne that keeps your cash flow and tax under control.

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