Tax instalments – are you paying too much?

The current economic climate has seen the income of many small businesses take a dramatic fall.  So the taxman is encouraging businesses to review their tax position to see if their pay-as-you-go (PAYG) tax instalments reflect their current financial position.

Some businesses or investment taxpayers may have received new PAYG notices from the tax office that reflect a predicted increase of up to 6% or 8% on their income in the coming year.

For many this is nonsense, but varying the PAYG instalment rate to accurately reflect likely total year income is extremely difficult in the current climate. And the threat of penalties if the variation is not substantially right (see below) doesn’t help.

Forcing SMEs and others to effectively guess their income for the year in current circumstances is near-on impossible. But businesses certainly don’t want to be paying more tax than they have to – cashflow is critical right now.

It all really requires a very special crystal ball to see the future right now. Your accountant or adviser can certainly help with this, but in the end many SMEs might find themselves relying on the tax office to be understanding and compassionate about income predictions, and hence downward variations to PAYG instalment rates.

Varying the instalment rate

It may be that some business taxpayers that use the instalment rate method for their PAYG instalments could end up paying more than their expected tax liability for the 2008-09 income year. If this is the case, they are entitled to vary their PAYG instalment rate to ensure that the correct amount of tax is paid.

An instalment rate can be varied where there has been a substantial change in the proportion of business and investment income that will be paid as tax. For example, if they expect to have much higher tax deductions for a similar level of business and investment income. Any overpaid instalments from previous quarters can then be applied to meet the current PAYG instalment.

But there is a sting. A business may be liable to pay a penalty (an incorrect variation general interest charge) where the varied instalment rate is less than 85% of what should have been used.

In these times, that can be tricky, to say the least. However, the tax office says it will look favourably where a taxpayer’s rate variation is considered reasonable at the time it was made.

The tax office says it will continue to support people and businesses trying to do the right thing in managing their tax liabilities, especially where they have demonstrated a good compliance record.

The tax office has provided a step-by-step guide about how to vary tax instalments. In essence, businesses can use this guide to vary their PAYG instalment amount or rate if they are one of three types of quarterly payers.

• If they pay four instalments each year on the basis of gross domestic product (GDP) adjusted notional tax. In this case, the business pays an amount the tax office has recommended – option one on the activity statement.
• If they pay two instalments each year on the basis of GDP adjusted notional tax. Here, the business pays an amount the tax office has recommended – option one on the activity statement.
• If a business pays instalments on the basis of instalment income. This is an instalment rate the tax office has recommended that the business use to work out the amount to pay based on its instalment income – option two on the activity statement.

The tax office uses the last assessed income tax return of a business to calculate and advise it of:

• A PAYG instalment amount that it should pay.
• An instalment rate that it can use to work out its instalment amount itself.

 A business can choose to vary its PAYG instalment rate or instalment amount if it estimates its business and investment income and the tax on this income, and the business:

• Thinks the amount or rate the tax office calculated will mean it will pay more (or less) than its expected tax for the income year.
• Thinks the amount or rate it varied earlier will mean it will pay more (or less) than its expected tax for the income year.

The business must then use the varied amount or rate for the remaining quarterly instalments in the income year, unless it varies again.

Not to vary?

Of course in practice, a business does not have to vary its PAYG instalment if the amount or rate the tax office calculated results in the business paying too much – the business will simply receive a refund of any overpayment of tax when the tax office assesses its income tax return.

But not varying when you know the PAYG rate will result in paying too much tax for the year can be a lost opportunity.

The difficulty is in getting the variation right. The tax office provides guides and help on this, but your accountant or adviser might be worth a call too.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.