Your ATO instalment notices arrive quarterly showing amounts that bear no resemblance to your actual tax position. Last quarter you paid $15,000 when your real quarterly tax liability was $8,000. This quarter the ATO wants $18,000 but your profit has dropped and you'll owe closer to $5,000.
This disconnect between PAYG instalments and actual tax creates two problems. Overpaying ties up cash you need for operations and growth. Underpaying triggers the General Interest Charge at 10.65% annually - and since 1 July 2025, that interest is no longer tax deductible.
This guide explains how PAYG instalments work, when and how to vary them, and how to avoid both overpayment (cash flow drain) and underpayment (expensive penalties). For businesses generating $2-$10 million annual revenue, getting instalments right can free up $20,000-$50,000 in working capital each year.
PAYG instalments are quarterly prepayments of income tax based on your previous year's tax liability. The ATO uses these instalments to collect tax progressively throughout the year rather than in one large payment when you lodge your return.
Individuals, sole traders, partnerships, and trusts enter the PAYG instalment system when they meet all three conditions:
Companies enter under similar thresholds (generally $4,000+ instalment income and $500+ estimated tax), though specific circumstances vary. The key distinction for companies earning over $2 million in business and investment income is method eligibility, not entry itself - these larger companies must use the instalment rate method rather than the instalment amount method (unless they qualify as a small or medium business entity).
Instalment income includes business income, professional income, investment income (interest, dividends, rent, royalties), and capital gains. It excludes salary and wages (already subject to PAYG withholding) and amounts with final withholding tax.
For most SMEs, instalment income comprises trading revenue, interest income, and investment property rent. A consulting business earning $3 million annually with $15,000 interest income has $3.015 million instalment income.
The ATO uses two methods to calculate instalments: instalment amount or instalment rate. Understanding which method applies and how it works helps you identify when variations make sense.
The instalment amount method takes your prior year tax liability, applies the GDP adjustment factor (4% for 2025-26), and divides by four quarters.
Calculation: (Last year's tax × GDP factor) ÷ 4 = Quarterly instalment
Example: Your 2023-24 tax was $80,000. For 2025-26, the ATO calculates $80,000 × 1.04 = $83,200 annual instalments, or $20,800 per quarter.
This method assumes your income and tax liability will grow at the GDP rate. If your actual income is stable or declining, you'll systematically overpay. If you're growing faster than 4% annually, you'll underpay.
The GDP adjustment factor changes annually based on economic conditions. Recent history: 6% for 2024-25, 6% for 2023-24, 2% for 2022-23. The 4% rate for 2025-26 reflects more moderate economic growth projections.
The instalment rate method applies a percentage (your instalment rate) to your actual quarterly instalment income.
Calculation: Quarterly instalment income × Instalment rate = Quarterly instalment
The ATO calculates your instalment rate by dividing your last year's tax by your last year's instalment income, expressed as a percentage. If you paid $80,000 tax on $2.5 million instalment income, your rate is 3.2%.
Each quarter, you report your actual instalment income on your BAS and apply the rate. If Q1 income is $650,000, your instalment is $650,000 × 3.2% = $20,800. If Q2 income drops to $400,000, your instalment is $12,800.
This method automatically adjusts for income fluctuations within the year, providing better alignment with actual tax liability than the fixed instalment amount method.
Companies with business and investment income above $2 million that don't qualify as small or medium business entities cannot use the instalment amount method - they must use the instalment rate method. This prevents large companies from underpaying tax by using outdated prior-year amounts when their current-year income has grown significantly.
Most SMEs in the $2-$10 million revenue range can choose either method, though the rate method typically provides better cash flow alignment for businesses with variable quarterly income.
PAYG instalments are calculated using historical data, but your current year tax position may differ substantially. Three common scenarios create mismatches.
Your business generated $2.8 million revenue in 2023-24 with $220,000 taxable income and $66,000 tax payable. In 2025-26, market conditions change and you're tracking toward $2.2 million revenue with $140,000 taxable income and $42,000 tax.
Under the instalment amount method, the ATO wants $66,000 × 1.04 = $68,640 annually, or $17,160 quarterly. But your actual quarterly tax liability is approximately $10,500. You're overpaying $6,660 per quarter, tying up $26,640 annually in excess tax payments.
This overpayment sits with the ATO earning no interest. You'll receive a refund when you lodge your 2025-26 return (October 2026 at earliest), but the cash is unavailable for 12-18 months when you could use it for operations, debt reduction, or investment.
Your business is scaling rapidly. Revenue grew from $2.5 million to $3.8 million year-on-year. Last year's tax was $75,000. This year you're projecting $140,000 tax liability.
The ATO's instalments total $75,000 × 1.04 = $78,000 annually ($19,500 quarterly). Your actual quarterly tax averages $35,000. You're underpaying $15,500 per quarter.
When you lodge your return, you owe $140,000 tax minus $78,000 instalments = $62,000 balance. If you can't pay immediately, this debt attracts General Interest Charge at 10.65% annually - and critically, this interest is no longer tax deductible from 1 July 2025.
A $62,000 debt accruing GIC for 6 months costs approximately $3,300 in non-deductible interest. This is pure cost with no tax benefit.
Your business has extreme seasonality. Q4 (April-June) generates 55% of annual revenue due to EOFY purchasing patterns. Q1-Q3 are relatively quiet.
Using the instalment amount method, you pay $18,000 each quarter regardless of actual quarterly profit. In Q1-Q3, you're overpaying relative to actual quarterly tax. In Q4, you're underpaying. The timing mismatch creates unnecessary cash flow pressure in low-revenue quarters.
The instalment rate method partially solves this by adjusting instalments to actual quarterly income, but it still applies last year's tax rate to this year's income, which may not align if your profit margin has changed.
Varying instalments aligns payments with your actual tax position, preventing both overpayment (cash flow drain) and underpayment (GIC penalties). The ATO allows variations each quarter independently.
For instalment amount method: Calculate your estimated annual tax for 2025-26. Divide by four. This becomes your quarterly instalment. Report this varied amount on your quarterly BAS (Label T8).
For instalment rate method: Calculate your estimated annual tax for 2025-26. Divide by your estimated annual instalment income. This gives your varied instalment rate. Report this rate on your quarterly BAS (Label T11).
Example (instalment amount variation): You estimate $95,000 tax liability for 2025-26. Divide by 4 = $23,750 per quarter. Even if the ATO calculated $20,800, you pay $23,750 and record this on your BAS.
Example (instalment rate variation): You estimate $95,000 tax on $2.8 million instalment income. Your varied rate is 3.39%. Apply this to actual quarterly income each quarter.
Vary early in the year when you first recognise a material change in profit trajectory. Waiting until Q4 to vary means you've already overpaid in Q1-Q3 (tying up cash for months) or underpaid in Q1-Q3 (accruing GIC).
The ATO calculates GIC from the quarterly due dates. If you underpaid Q1 (due 28 October) and don't correct until lodging your return (October 2026), you've accrued GIC for 12 months on that quarterly shortfall.
Conversely, if you overpay Q1-Q3 due to conservative estimates, that excess sits with the ATO interest-free until your return is processed. Early variation based on current year actual performance optimises cash flow.
When you vary, maintain documentation supporting your estimate: current year management accounts, profit and loss statements, cash flow forecasts, and assumptions for the remainder of the year.
The ATO may request this documentation if your variation differs materially from their calculated amount. Documented, reasonable estimates demonstrate good faith variation rather than attempted tax avoidance.
For businesses with regular monthly financial reporting, this documentation is straightforward - you already have current year profit trends. For businesses without monthly management accounts, preparing estimates requires more effort but remains essential for accurate variation.
Underestimating instalments triggers the General Interest Charge on the shortfall between instalments paid and actual tax liability. GIC rates are punitive and since 1 July 2025, non-deductible.
GIC for January-March 2026: 10.65% annually, 0.02917808% daily
The ATO calculates GIC daily on the outstanding balance from the instalment due date until you pay. Rates change quarterly based on 90-day Bank Bill rate plus 7% uplift.
Recent quarterly rates: October-December 2025 was 10.61%, July-September 2025 was 10.78%. The ATO announces new rates approximately 2 weeks before each quarter begins.
The Treasury Laws Amendment (Electric Car Discount) Act 2025 made GIC non-deductible for shortfall interest charges and general interest charges imposed on or after 1 July 2025, regardless of when the underlying debt originated.
Previously, GIC was deductible under Section 25-5 ITAA 1997 as a cost of earning assessable income. This deductibility partially offset the penalty cost. At 30% corporate tax rate, $10,000 GIC cost $7,000 after-tax ($10,000 GIC minus $3,000 tax saving).
From 1 July 2025, that same $10,000 GIC costs the full $10,000 with no tax relief. This makes underpayment approximately 43% more expensive for companies (30% ÷ 70% = 43% increase in after-tax cost).
Scenario: You underestimate your PAYG instalments by $50,000 for the 2025-26 year. When you lodge your return (October 2026), you owe this shortfall plus GIC from the quarterly due dates.
Simplified calculation (assuming even quarterly underpayment of $12,500 and 10.65% annual rate):
Your $50,000 underpayment created $3,323 in pure cost with no tax benefit. For perspective, short-term business finance at 8% would cost $2,800 annually and be tax deductible, netting to $1,960 after-tax cost for companies.
The GIC penalty is both more expensive and non-deductible, making accurate instalment management financially critical.
The ATO provides a safe harbour: if your total instalments paid equal at least 85% of your actual tax liability, you don't incur GIC even if you underpaid.
Example: Your actual 2025-26 tax is $120,000. If you paid at least $102,000 in instalments (85% × $120,000), no GIC applies even though you underpaid by $18,000. You still owe the $18,000 when you lodge, but without interest penalties.
This safe harbour protects businesses that make good faith estimates but miss by modest amounts. It doesn't protect deliberate or reckless underestimation.
Conservative variation strategies balance cash flow optimisation with GIC risk avoidance.
Rather than varying to exactly 100% of your best estimate, vary to 90% of estimated tax liability. This provides 5-percentage-point buffer above the 85% safe harbour threshold.
Example: You project $110,000 tax for 2025-26. Vary to $99,000 annually ($24,750 quarterly). If your actual tax lands anywhere from $99,000 to $117,000 (90% to 106% of estimate), you've optimised cash flow without triggering GIC.
The 10% buffer accounts for normal estimation uncertainty. Few businesses forecast tax liability to exact precision 12 months in advance. Building in conservative margin prevents GIC from minor estimation errors.
Vary based on first-half actual results rather than full-year projections. After Q2 (December quarter), you have 6 months of actual financial data showing profit trends, margin changes, and income trajectory.
Update your estimate for Q3 and Q4 instalments based on H1 actuals extrapolated forward. This reduces estimation error because you're working with real data rather than pure forecasts.
Example: Budget projected $120,000 tax. After Q2, your actual profit suggests $95,000 tax is more realistic. Vary Q3 and Q4 instalments to reflect the revised estimate.
When varying, document the assumptions behind your estimate. For profit projections, note expected revenue growth rates, gross margin assumptions, operating expense budgets, and one-off items (capital expenditure, restructuring costs, client losses).
Conservative assumptions provide defensibility if the ATO queries your variation. Assuming 5% revenue growth when you're tracking 12% is reasonable conservatism. Assuming -20% revenue decline when you're tracking +5% growth is not.
The ATO expects reasonable estimates based on available information at the time of variation. They don't expect perfect accuracy, but they do expect good faith effort to project realistic tax liability.
Overpaying PAYG instalments creates opportunity cost that compounds quarterly.
For a business with $2.5 million revenue, $180,000 taxable income, and $54,000 actual tax liability, the ATO might calculate $68,000 annual instalments based on prior year activity. The $14,000 annual overpayment ($3,500 quarterly) ties up cash for 12-18 months until your return is processed and refund issued.
At $3,500 overpayment per quarter, you've tied up $3,500 for Q1 (12 months until refund), $7,000 for Q1+Q2 (9 months average), $10,500 for Q1+Q2+Q3 (6 months average), and $14,000 for all four quarters (3 months average). Weighted average cash tied up is approximately $8,750 for 9 months.
That $8,750 tied up with the ATO could reduce debt, fund inventory, or support expansion. If your business pays 7% on overdraft facility, the opportunity cost is approximately $460 annually.
For larger businesses overpaying $40,000-$60,000 annually, the opportunity cost is $2,100-$3,150 at 7% cost of capital. This is real cash that could reduce interest expense or fund growth.
PAYG instalments are one of four major quarterly tax obligations for most SMEs. The cumulative cash flow impact requires coordination.
Business Activity Statements combine GST, PAYG withholding, and PAYG instalments in quarterly filings. Due dates align: 28 October, 28 February, 28 April, 28 July for most businesses.
For a business with $600,000 quarterly revenue ($60,000 GST collected), $120,000 quarterly wages ($30,000 PAYG withheld), and $18,000 quarterly PAYG instalments, the total quarterly BAS payment is approximately $48,000 assuming some GST credits for business purchases.
This $48,000 quarterly obligation creates predictable cash flow requirements. Businesses with strong Q4 revenue but weak Q1 revenue need to manage timing carefully - Q4 BAS (due 28 July) reflects strong Q4 activity, but cash may be tight in July if Q1 revenue is slow.
Superannuation is paid quarterly with due dates 28 October, 28 January, 28 April, 28 July. For 2025-26, the SG rate is 12% of ordinary time earnings.
A business with $120,000 quarterly wages pays approximately $14,400 quarterly super. This coincides with BAS payments, creating combined quarterly obligations of $62,400 ($48,000 BAS + $14,400 super).
Businesses with Australia-wide wages above state thresholds (generally $1.2-$1.3 million annually) pay payroll tax monthly or quarterly. Rates vary by state (4.75%-5.45% on wages above threshold).
A NSW business with $2.5 million annual wages pays approximately 5.45% on wages above $1,200,000 threshold = $70,850 annually, or $17,712 quarterly.
For a NSW business with $2.5 million revenue, $500,000 annual wages, $18,000 PAYG instalments quarterly, the combined quarterly obligation is approximately:
This $72,400 hits every quarter like clockwork. Businesses need cash reserves or receivables collection timed to meet these obligations without scrambling for working capital each quarter.
PAYG instalment management is straightforward in theory but complex in practice. Three situations justify professional financial support.
If your quarterly profit varies by more than 25% quarter-to-quarter, accurately projecting full-year tax becomes challenging. Professional financial support provides monthly management accounts showing actual profit trends, making variation decisions data-driven rather than guesswork.
Businesses operating through company groups, trusts, or partnership structures face complexity in calculating consolidated tax positions. Professional support ensures you're considering all entities' tax liabilities and cash flow timing when varying instalments.
Businesses growing 30%+ annually have rapidly changing tax positions. Last year's tax becomes irrelevant within months. Professional support provides rolling forecasts that update quarterly as actual results come in, preventing both overpayment (wasted cash) and underpayment (GIC penalties).
PAYG instalment management requires current financial data and forward-looking projections. Most businesses lack both.
Scale Suite provides daily financial visibility through integrated reporting. You see current month profit trends by day 5 of the following month, not 45-60 days later when traditional accountants deliver quarterly management accounts.
This real-time visibility enables confident variation decisions. When Q1 results show profit tracking 20% below budget, you vary Q2 instalments immediately based on actual data, not stale projections from your last budget.
Monthly management reporting includes rolling 12-month forecasts that update as actuals replace projections. By month 3, your full-year forecast incorporates Q1 actuals plus updated assumptions for the remaining 9 months. This rolling forecast accuracy prevents the GIC traps that catch businesses using static annual budgets prepared in July.
For businesses managing multiple quarterly obligations (BAS, super, payroll tax, PAYG instalments), embedded finance teams provide the cash flow forecasting and obligation tracking that prevents surprises. You know by mid-quarter whether you'll have cash to meet month-end obligations, allowing time to manage receivables collection or arrange short-term facilities if needed.
Can I vary my PAYG instalments to zero if I expect a loss this year?
Yes, you can vary to zero if you genuinely expect no tax liability. However, varying to zero while remaining profitable will likely trigger ATO attention. If you vary to zero and subsequently lodge a return showing taxable income, you'll owe the full tax amount plus GIC from the original due dates. Only vary to zero if you have documented evidence supporting a genuine expectation of loss or nil tax.
What happens if I overestimate and pay too much in instalments?
You receive a refund when you lodge your return. The ATO pays no interest on overpaid instalments, so you've provided them an interest-free loan. This is why conservative variation (paying 90-95% of estimated tax rather than 100%) makes more sense than aggressive overpayment. The safe harbour threshold is 85%, so any amount above that is just tied-up cash.
How does the ATO know if I've underestimated my instalments?
When you lodge your annual return, the ATO compares total instalments paid to actual tax liability. If instalments were less than 85% of actual tax, they automatically calculate and charge GIC for each quarterly shortfall. There's no manual review required - the system calculates it based on your return data.
Can I switch between instalment amount and instalment rate methods mid-year?
No, you choose your method annually and must use it consistently for all four quarters. You can change methods for the next financial year by notifying the ATO, but mid-year switching isn't permitted. However, you can vary within either method as frequently as each quarter.
Do I pay instalments on one-off capital gains?
Yes, capital gains are included in instalment income. If you sell an investment property in Q2 with $150,000 taxable capital gain, this increases your Q2 instalment income. Under the rate method, your Q2 instalment automatically adjusts upward. Under the amount method, you should vary your Q3 and Q4 instalments to account for the additional tax liability.
What if my instalment rate seems wrong compared to my actual tax rate?
Your instalment rate is calculated from prior year data (last year's tax ÷ last year's instalment income). If your business has changed materially - different profit margins, new income streams, restructured operations - the prior year rate won't reflect current reality. Vary to a more appropriate rate based on your current year projected tax liability and instalment income.
How do I vary instalments if I'm using Xero or MYOB accounting software?
Most accounting software allows you to override the ATO-calculated instalment amount on your BAS. Enter your varied amount in the PAYG instalment field (Label T8 for amount method, T11 for rate method) when completing your quarterly BAS. The software will use this amount instead of the ATO's default. Ensure you maintain documentation in your files explaining why you varied and how you calculated the new amount.
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