Thinking About Reducing Your PAYG Instalment? The ATO’s 85% Rule Could Cost You
A variation can be completely legitimate - but reducing PAYG simply because cash is tight can create another problem later.
Written by: Melissa Cunliffe (CA)
There are plenty of legitimate reasons why a business might reduce its PAYG instalments. Profit may have fallen, margins may have tightened, a major customer may have left, interest costs may have risen or a significant deduction may arise.
But there is a big difference between saying “our expected tax liability has genuinely fallen” and “we do not have the cash to pay this quarter”.
The first can be appropriate tax management. The second may simply defer a cash-flow problem.
When might a variation be reasonable?
Imagine last year a business made $600,000 taxable profit. This year current management accounts show it is tracking toward $350,000 because sales and margins have fallen.
If PAYG continues to reflect the stronger historical year, the business may prepay substantially more tax than is ultimately required. A variation may be reasonable.
The key is that it is based on a genuine expectation of the current year's tax outcome.
What is the PAYG instalment 85% rule?
Broadly, where a taxpayer varies PAYG instalments and the amount paid is less than 85% of the amount that should ultimately have been paid, General Interest Charge may apply to the shortfall.
The rule discourages taxpayers from artificially reducing instalments simply to hold cash during the year.
A simple example
A company estimates its annual instalment liability at $80,000. When the tax return is prepared, the relevant amount turns out to be $120,000.
Eighty-five per cent of $120,000 is $102,000. The company paid only $80,000 and has fallen outside the threshold.
It still owes the tax and may also face interest consequences.
Cash flow is not taxable profit
A business can have terrible cash flow and still make taxable profit.
Cash may be tied up in debtors, stock, work in progress, loan principal repayments, equipment purchases or owner drawings. Those things do not automatically mean taxable profit has fallen.
So if the business says “we cannot afford the PAYG”, the next question should be: “Has the expected tax liability actually fallen?”
If not, the instalment may not be the real problem.
What should support a variation?
A material variation should be based on evidence such as:
• current management accounts;
• year-to-date taxable profit;
• realistic revenue and margin forecasts;
• major deductions and depreciation;
• interest costs;
• tax losses;
• asset sales or one-off transactions; and
• expected changes during the remainder of the year.
A useful test is: Can we explain why the original instalment is too high and show the numbers behind that conclusion?
Do not set and forget
A forecast prepared early in the year can become wrong. Trading may improve, a contract may be won, an asset may be sold or margins may recover.
Revisit the estimate during the year. A good variation is based on the best information available at the time.
A variation does not reduce tax
Reducing PAYG changes when cash is paid. It does not itself reduce the underlying income tax.
If the business ultimately makes the same taxable profit, the same tax generally remains payable. An aggressive variation may simply create a larger year-end bill.
What if the business genuinely cannot pay?
That is a cash-flow issue rather than necessarily an instalment calculation issue.
Where the obligation is correct but the business cannot pay, the response may involve dealing with the ATO, reviewing funding, drawings, debt, pricing, debtor collection or profitability.
Reducing a correct instalment just to match available cash can hide the underlying problem.
Why GIC matters more now
General Interest Charge can make tax debt expensive, and GIC has not been deductible since 1 July 2025. Deliberately using underpaid tax instalments as working capital is therefore increasingly unattractive.
Ask the bigger questions
If PAYG suddenly feels unaffordable, ask:
• Has profit actually fallen?
• Has gross margin changed?
• Are debtors slower?
• Have owner drawings increased?
• Are loan repayments absorbing cash?
• Has stock grown?
• Is capital expenditure too high?
• Are wages rising faster than revenue?
• Is tax being adequately provisioned?
PAYG can be the symptom. It may not be the problem.
Where the 4P's framework fits
People: good forecasting reduces stress around tax bills.
Preserve: avoid overpaying instalments where profit has genuinely fallen.
Protect: support variations with sound forecasts and documentation.
Prosper: use the same information to make better pricing, employment, equipment and cash-flow decisions.
Before reducing the next instalment, ask three questions:
1. Has expected taxable profit genuinely fallen?
2. What current financial information supports that conclusion?
3. Could we explain the calculation if the ATO asked?
If the answer is yes, a variation may be entirely appropriate. If the real answer is “we just do not have the cash”, understand why the cash is not there before treating PAYG as the solution.
Before making a variation, make sure the numbers support a genuine reduction in expected taxable profit rather than simply reflecting a temporary cash flow problem.
Book a consultation with 4P's Future Accounting to review your current financial position, forecast your tax liability and determine whether a PAYG variation is appropriate for your business.
Disclaimer
This article does not constitute financial advice and is for general information only. It does not take into account any individual’s personal objectives, situation or needs, and is not intended as professional advice. Any similarity to an individual’s personal circumstances and the examples provided in this article is purely coincidental. Any person acting upon such information without receiving specific advice, does so entirely at their own risk.
Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this article and the author plus Future Accounting Group Pty Ltd is not acting in its capacity as an Australian Financial Services Licence holder
Liability limited by a scheme approved under professional standards legislation.
