PAYG Instalment

What is it?  ...and what makes it different to PAYG withholding?

Tax is paid by both individuals and businesses alike, and if you are employed, then your employer deducts tax from your salary and forwards it to the Australian tax office to cover the tax liability that you will have once your tax return is submitted and the tax department issues you your tax assessment.   If that assessment is less than the amount of PAYG withholding deducted from your salary for the past year, then you will receive a tax refund.   If however that assessment is more than the PAYG withheld from your salary, then you will be issued with a request to pay the difference between the PAYG deductions for the year and the tax assessment

The PAYG instalment is the amount of money a business sends to the ATO each and every quarter with their BAS statement.   This is to make provision for the end of financial year tax liability of the business.   In the same way as PAYG withholding, once the tax returns at the end of the year are finalised, and the ATO has assessed the amount of tax due on the business taxable income, either a request is made for the payment of any shortfall or a refund is paid to the business for any excess of monies paid throughout the year in PAYG Instaments.

These PAYG instalment may take the form of either a fixed quarterly payment, or it could take the form of a percentage of the quarterly gross revenue of the business.   Both of these have their foundations based in the previous tax liability of the business in year just past.

This instalment seems to often be an area of confusion for bookkeepers.  There also seems to be a trend among bookkeepers to post this PAYG instalment to liabilities when it is paid, and for this reason this blog post is directed toward this issue.

The PAYG Instalment is an amount of money placed in reserve to cover the tax liability for the current year.   The value of this tax liability will not be known until the tax return has been done and the ATO assessment has been completed.     What I want you to notice here is that a payment is made that will be for a liability that will occur after the end of the current financial year.

Many times I see this pre-payment allocated to liabilities which is clearly incorrect, so why do so many bookkeepers do this?  

Could it be that they are not thinking so much about the fact that it is a payment made to the ATO as a reserve for a liability that I know will be coming, but rather that it is a future liability that will occur.    It could even a case of the person who taught me to do this told me it should be placed there.   This though is not yet a liability! 

We are faced with the question of what is correct and why is it so?   For those of you old enough to remember, this was the question always and Iasked by Professor Julius Sumner Miller when exploring physics.   Yes I hear you say, this is not physics, it is accounting, and you are correct, however as my mentor in accounting was always heard to say, accounting is an art not a science.  If you think about this you would have to agree because the true art of accounting is to be able to look at a transaction, and see things in it that others cannot see.   Most people look at the transaction without the ability to think it through in depth to identify the most appropriate way to enter a transaction, or cannot see the adverse consequences a transaction entry may have further down the bookkeeping pathway.

As this is a payment making a provision for a future liability, it is treated as such.  Just because we pay this provision into our reserves held by the ATO, it is no different to paying this provision into our reserves at the bank.  The difference is that the ATO gains the interest on those reserves and not us.  When the tax assessment is completed by the ATO, a payment would be made from our reserve bank account to the ATO to cover that liability.   If we have been paying monthly reserves to the ATO then the tax liability would be applied by the tax assessment and any shortfall requested from us, or any excess would be returned to us in the form of a refund cheque.

The journal entries to apply this pre-payment to the tax assessment would be:-

In the event of an under provision...

Credit the Asset Tax provision account by its full value

Credit the bank for the additional payment to cover the shortfall

Debit the income tax expense account

In the event of an over provision...

Credit the Asset Tax provision account by the value of ther tax assessment

Debit the income tax expense account

When the refund cheque is received from the ATO...

Debit the bank

Credit the Asset tax provision account

Debit the income tax expense account