What Is Notional Tax? Pay As You Go Installment Explained

Nobody wants a surprise tax bill landing in their lap at the end of June, especially when cash flow is already doing its best impression of a rollercoaster. That’s exactly the problem notional tax and PAYG instalments are designed to solve. In Australia, notional tax is the ATO’s estimate of the income tax you’re likely to owe this financial year, based on what you earned last year. The ATO uses this figure to work out your quarterly pay-as-you-go instalment amounts, spreading your tax across the year so you’re never scrambling to cover a massive lump sum.

The ATO will either automatically opt you into PAYG instalments, or your accountant will set it up on your behalf. Here’s everything you need to know about how it works, and how the ATO calculates what you owe.

What is a Pay As You Go instalment (PAYGI)?

A PAYG instalment is a quarterly prepayment of the tax on your business and investment income, based on your predicted tax bill for the year. Instead of facing one large amount at EOFY, which plenty of business owners simply don’t have sitting around, you chip away at it in manageable chunks throughout the year.

It’s worth noting that this is completely separate to PAYG withholding, which is the tax employers deduct from their employees’ wages. Easy to mix up, but a very different beast.

How Do You Enter PAYGI?

You can enter the PAYG instalment system in one of two ways: automatically through the ATO, or proactively through your accountant.

For individuals (including sole traders) and trusts, the ATO will automatically enrol you if your most recent tax return shows all 3 of the following (ATO source):

• Instalment income of $4,000 or more
• Tax payable on your notice of assessment of $1,000 or more
• Estimated notional tax of $500 or more

Note: Companies and super funds have different entry thresholds, a company enters automatically once its instalment income exceeds $2 million. If you’re unsure which thresholds apply to your entity structure, your accountant can check.

That said, a good accounting firm will often set you up with PAYG instalments before the ATO forces the issue, and for good reason. It keeps your cash flow predictable, avoids the pain of a single massive tax bill, and steers you clear of ATO payment plans, which, while manageable, carry accruing interest (GIC at around 11%, non-deductible since July 2025) and can appear on the ATO’s Business Credit Register for larger debts, which some lenders review. Think of it as your accountant doing you a favour before you even knew you needed one.

How Does the ATO Calculate Notional Tax?

The ATO notional tax calculation starts with your most recently lodged tax return. From there, they use one of two methods depending on how you pay your instalments.

The Rate Method Formula

If you’re using the rate method, the ATO calculates your instalment rate like this:

(Estimated notional tax ÷ instalment income) × 100 = instalment rate %

In plain English: they take your total taxable income from your last return, apply the relevant tax rates to get your estimated notional tax, then divide that by your instalment income to arrive at a percentage. That percentage is what appears on your quarterly activity statement, and you apply it to your actual income each quarter.

The Amount Method

If you’re on the amount method, the ATO simply gives you a fixed dollar figure to pay each quarter, calculated from that same notional tax estimate, with no maths required on your end. Most straightforward option if your income is fairly consistent.

The GDP Adjustment: Why Your Bill Might Be Higher Than Last Year

Here’s something that catches plenty of business owners off guard: the ATO doesn’t just use your previous year’s figures as-is. They apply a GDP adjustment factor to account for expected income growth across the economy. 

For the 2025–26 income year, that adjustment is 4%, meaning your instalment amount may be slightly higher than your last return alone would suggest. (Note: the GDP adjustment factor is updated annually by the ATO. This figure applies to 2025–26 and will change for 2026–27. Also worth noting: the GDP adjustment only applies if you’re on the amount method, if you’re using the rate method and calculating your own instalments, it doesn’t affect you.)

It’s the ATO’s way of keeping pace with a growing economy, even if your own income hasn’t moved quite as fast.

Do I have to pay notional tax? If you meet the PAYGI entry thresholds above, yes, the ATO will use your notional tax estimate to set your instalments. But you’re not locked in. If your income changes significantly during the year, you can vary your instalment amount (more on that below).

What happens once you’re on PAYGI?

Once you’re in the system, you’ll make regular pay as you go payments throughout the year, quarterly for most people, based on your business and investment income. Each payment is essentially a pre-payment toward your estimated annual tax bill, using the ATO’s notional tax figure as the baseline.

At EOFY, all those instalments are added up and offset against your actual tax liability. Get the estimate right and you’ll have little to nothing left to pay, or even a refund coming your way.

PAYG Instalment Due Dates

Miss a due date and interest charges start ticking, so it’s worth knowing when they fall:

Note: The dates above are the standard due dates for self-lodging taxpayers. If you lodge through a registered tax agent (like Future Advisory), you may be eligible for extended due dates under the Tax Agent Lodgment Program. Check with your accountant to confirm your specific dates, don’t assume the table above applies to you without asking.

What If the ATO’s Notional Tax Estimate Is Wrong?

It happens more often than you’d think, especially after a big year followed by a quieter one, or if you’ve recently changed your business structure or taken on fewer clients. The good news is you can vary your PAYG instalment at any time if you believe the notional tax figure doesn’t reflect where your income is actually heading this year.

You do this through your tax agent or ATO online services. One word of caution though: if you vary it down and end up underpaying by more than 15%, the ATO can charge interest on the shortfall. So be realistic rather than optimistic when lodging a variation, run the numbers with your accountant before you do anything.

Questions? Concerns? You know where to find us.

FAQ

What is notional tax in Australia?

Notional tax is the ATO’s calculated estimate of the income tax you’re expected to owe for the current financial year, based on your most recent tax return. It’s called “notional” because it’s an approximation, not your final bill. The ATO uses this figure to set your quarterly PAYG instalment amounts, so you’re pre-paying your tax throughout the year rather than copping it all at once.

What does notional tax mean on my activity statement?

When you see a notional tax figure on your activity statement, it’s the ATO’s estimate of your annual tax liability, expressed either as a dollar amount (amount method) or a percentage rate (rate method) applied to your instalment income. It’s the number driving how much you pay each quarter in pay-as-you-go instalments.

How does the ATO calculate notional tax for PAYG instalments?

The ATO uses your most recently lodged tax return as the starting point. For the rate method, the formula is: (estimated notional tax ÷ instalment income) × 100. They also apply a GDP adjustment factor, 4% for 2025–26, to account for likely income growth. The result is the instalment rate that appears on your activity statement each quarter.

What is the GDP adjustment and why does it affect my PAYG instalments?

The GDP adjustment is a percentage the ATO applies to your notional tax calculation to account for Australia’s expected economic growth. For 2025–26 it’s set at 4%. This means your instalment amount may be slightly higher than your previous year’s figures alone would suggest. It only applies to the amount method, not if you’re using the rate method to calculate your own instalments.

Do I have to pay notional tax?

If you meet the ATO’s PAYGI entry thresholds, instalment income of $4,000+, tax payable of $1,000+, and notional tax of $500+, then yes, you’ll be enrolled in the PAYG system and required to make quarterly payments based on your notional tax estimate. However, you’re not stuck with the figure the ATO sets. You can vary your instalments at any time if your income has changed significantly.

Can I reduce my PAYG instalments if my notional tax is too high?

Yes. If the ATO’s notional tax estimate doesn’t reflect your current income, say you’ve had a slower year or changed your business structure, you can lodge a variation through your tax agent or ATO online services. Just be careful: If you vary it down and end up underpaying by more than 15% of what you actually owe, the ATO can charge shortfall interest, under section 45-230 of Schedule 1 to the Taxation Administration Act 1953. The ATO’s guidance notes that penalties won’t apply where you’ve made a reasonable and genuine attempt to estimate your liability — but “being optimistic” doesn’t qualify as reasonable care. Run the numbers with your accountant before you vary. Get your accountant to run the numbers before you vary.

What’s the difference between notional tax and actual tax payable?

Notional tax is the ATO’s estimate, it’s what drives your quarterly instalment payments. Actual tax payable is the real number determined when you lodge your annual tax return. The difference between the two is settled at EOFY: if your instalments covered more than you owed, you get a refund. If they fell short, you pay the gap.

What’s the difference between the PAYG amount method and rate method?

With the amount method, the ATO gives you a fixed dollar figure to pay each quarter based on your notional tax estimate, simple and predictable. With the rate method, you apply your instalment rate to your actual quarterly income, better suited to businesses where income varies a lot throughout the year. Your accountant can help you figure out which method suits your situation.

Do sole traders and companies pay notional tax differently?

The concept of notional tax is the same across entity types, it’s always the ATO’s estimate of what you’re likely to owe this year. But the entry thresholds and rate caps differ materially. Sole traders, individuals, and trusts enter PAYGI automatically at instalment income of $4,000+, tax payable of $1,000+, and notional tax of $500+. Companies and super funds enter automatically once instalment income reaches $2 million or more.

The ATO caps instalment rates at a “reasonable” maximum for each entity type (ATO reasonable instalment rates):

• Individuals (including sole traders) and trusts: 55%
• Superannuation funds and SMSFs: 45%
• Corporate tax entities (companies): 30%

If the ATO’s calculated rate exceeds these caps, it will automatically reduce it to the maximum before it appears on your activity statement.

Your accountant can confirm which thresholds and caps apply to your specific structure.

Once you’re in the PAYG system, the quarterly payment process works similarly regardless of your structure.

Where can I find my notional tax figure from the ATO?

Your notional tax amount appears on your PAYG instalment notice, sent quarterly by the ATO. You can also find it in your ATO online services account via myGov. If you’re unsure what the figure means or whether it looks right for your current income, your accountant can review it and lodge a variation if needed.