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  • PAYG withholding gap

    The pay as you go (PAYG) withholding gap is an estimate of the difference between the tax that should have been withheld by employers from salary and wages paid to their employees according to the law (theoretical PAYG withholding), and the actual amounts of income tax withholding from salary and wages received by us for a defined period, typically a financial year.

    Under the Taxation Administration Act 1953, employers have an obligation to collect tax from payments made to employees and remit that tax to the ATO. Employers must register with us under the PAYG withholding scheme to do this.

    PAYG withholding provides an effective way for most people to meet their annual income tax obligations. The withholding system also ensures we collect a more stable, secure source of revenue throughout the year. This revenue supports a range of community services.

    Key facts on PAYG withholding for 2015-16 financial year include:

    • there were about 905,000 employers
    • $176 billion PAYG withholding was paid by employers to the ATO
    • 95% of PAYG withholding was paid to us on time.

    Note: Businesses can use our Employee/contractor decision tool to determine if a worker is an employee or contractor for tax and super purposes.

    Find out about:

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    Measuring the gap

    We use a top-down approach to estimate the PAYG withholding gap, using data from the Australian Bureau of Statistics (ABS), Treasury and the ATO. This compares the following for a financial year:

    • the total individuals income tax withholding minus non-salary and wages withholding, as reported to us on an accruals basis
    • the theoretical PAYG withholding from salary and wages calculated using external economic data.

    External data is used to estimate total salary and wages paid. We then apply an average rate of withholding to determine the theoretical total liability.

    We use ATO data to determine the total PAYG withholding revenue, both voluntarily and as a result of direct ATO intervention.

    The difference between the theoretical liability and actual ATO collections gives us the estimate for the PAYG withholding gap.

    We include an estimate of the impact of the black economy in our PAYG withholding calculation. This inclusion supports the medium reliability rating as we are providing a full and holistic view of wages and employment.

    Not all the PAYG withholding gap is lost revenue. While an employer may not deduct the correct amount, employee taxpayers will be required to pay additional tax upon lodging their income tax return and correctly reporting their income.

    Trends and latest findings

    The tax gap estimate in percentage terms for PAYG withholding is relatively low.

    There is generally a high level of voluntary compliance in the PAYG withholding system. We estimate that employers are paying about 95% of the PAYG withholding they are required to without intervention from us.

    The net gap typically ranges from approximately 2% to 4% of the total value of PAYG withholding and has seen significant revisions in the past which are due to external data changes.

    In 2015-16 the net gap was $3.4 billion, equating to 1.9% of the total theoretical value.

    Overall we observe that the PAYG withholding net gap (including non-pursuable debt) has been shrinking. As there are margins of error due to limitations in the methodology, caution needs to be taken when looking at individual year results. We note that the ABS data indication of weak wage growth flows through to the gap measurement.

    The measurement differences between the PAYG withholding data and the Compensation of Employees data continue to lead to revisions of the gap estimate. We continue to monitor this and engage with the ABS to understand the drivers of this change. Some potential causes include ongoing suppressed wage growth reflected in the national accounts, reductions in small employers in the market and shifts from traditional employees to other work arrangements. Australia’s PAYG withholding gap is slightly higher than similar estimates made by the United Kingdom's pay as you earn (PAYE) gap of 1.2% for 2015-16. The UK has also seen a considerable decline in their PAYE gap over recent years.

    The following table shows the PAYG withholding revenue reported, adjustments, gross and net PAYG withholding gap estimates for the period 2010-11 to 2015-16.

    PAYG withholding gap ($ millions), 2010-11 to 2015-16

    Gap

    2010–11

    2011–12

    2012–13

    2013–14

    2014–15

    2015–16

    Theoretical PAYG withholding

    132,509

    145,349

    151,002

    158,000

    167,086

    173,481

    Impact of the black economy

    1,667

    1,825

    1,888

    1,973

    2,091

    2,172

    Adjusted theoretical PAYG withholding

    134,177

    147,174

    152,890

    159,974

    169,177

    175,653

    PAYG paid

    127,440

    140,356

    146,929

    154,226

    162,420

    169,333

    Gross gap

    6,737

    6,818

    5,960

    5,747

    6,757

    6,320

    Amendments

    935

    749

    1,502

    1,374

    2,318

    2,964

    Net gap

    5,802

    6,069

    4,459

    4,373

    4,439

    3,356

    Gross gap (%)

    5.0%

    4.6%

    3.9%

    3.6%

    4.0%

    3.6%

    Net gap (%)

    4.3%

    4.1%

    2.9%

    2.7%

    2.6%

    1.9%

    Notes:
    • Changes from previously published estimates occur for a variety of reasons, including improvements in methodology, revisions to data and additional information becoming available. The black economy estimate increases previously published results by between $1.5 billion and $2.1 billion per year.
    • Due to data lag, estimates for tax years 2016–17 and 2017-18 are not yet available.
    • The results provided in this estimate are to be considered preliminary due to being subject to revision in line with the national accounts datasets administered and revised by the ABS.

    The graph below shows the trend in tax reported and the net PAYG withholding gap over the same period.

    Amount paid and net gap – PAYG withholding, 2010-11 to 2015-16

    This graph provides a visual representation of the trend of PAYG withholding reported and net gap. This information is provided in the table listed earlier in this document.

    Data sources: ABS, Treasury and ATO data.

    PAYG withholding gross and net gap percentages

    This graph provides a visual representation of the trend of gross and net gaps as a percentage. This information is provided in the table listed earlier in this document.

    ATO action to reduce the gap

    A range of taxpayer behaviours can affect the gap. These can arise through employers failing to notify or withhold PAYG withholding. The main events contributing to this risk include employers:

    • failing to withhold and / or under-reporting PAYG withholding
    • failing to report or pay withholding on time
    • incorrectly treating employees as contractors.

    These risk events are driven by a range of factors including:

    • businesses being impacted by unforeseen events which puts pressure on their cash flow
    • pressure from competitors who are deliberately under paying staff and / or avoiding tax obligations to gain an advantage
    • businesses struggling with the distinction between an employee and a contractor.

    We focus our efforts in two main areas:

    • prevention activities that aim to help employers to get things right and deal with genuine mistakes
    • correction activities that deal with opportunistic or deliberate behaviour.

    We assist employers to get it right and promote a level playing field by:

    • producing online help and assistance products to encourage voluntary compliance
    • demonstrating our tools and calculators in all interactions with clients
    • conducting information sessions via seminars, webinars and visits to professional bodies, associations and industry groups.

    Our targeted correction activities focus on those at the highest risk of non-compliance. We educate employers that have made a mistake to encourage full re-engagement with the tax system. Indications are that compliance improves in following years.

    This includes conducting reviews and audits of employers at high risk of incorrectly treating employees as contractors.

    Methodology

    The PAYG withholding gap is an estimate of the difference between the tax that should have been withheld by employers from salary and wages paid to employees according to the law (theoretical PAYG withholding), and the actual amounts of income tax withholding from salary and wages received.

    We use a top-down approach to estimate the PAYG withholding gap, which compares total individuals income tax withholding minus non-salary and wages withholding and theoretical PAYG withholding from salary and wages calculated using external economic data.

    The gap estimate is made on the basis of the law as applicable for the relevant income year. New or recent law changes will not be reflected in gap estimates.

    Here we outline the methodology we have selected to estimate the PAYG withholding gap. We detail our assumption, limitations, data sources and reliability rating as assessed by our independent expert panel.

    Selecting the methodology

    Actual PAYG withholding revenue is calculated on an accrual basis, matching revenue to the income year in which the liability occurred, rather than to the income year in which the revenue is received.

    In selecting a methodology we researched and considered the full range of options available including ‘top-down’ and ‘bottom-up’ methods.

    We adopt a top-down methodology largely based on available data from the ATO and ABS. This is considered the most suitable given the broad-based nature and size of the population.

    Applying the methodology

    We undertake a five-step process to estimate the PAYG withholding gross gap, as described in detail below.

    Steps to estimate the PAYG withholding liability

    Steps to estimate the PAYG withholding liability The five steps to estimate the PAYG withholding liability are:  Step 1: Estimate salary and wages subject to withholding (including an adjustment for the black economy) Step 2: Multiply Step 1 by average rate of withholding to determine theoretical PAYG withholding Step 3: Calculate PAYG withholding received, subtracting exclusions and non-applicable amounts Step 4: Subtract Step 3 from Step 2 to determine the PAYG withholding net gap Step 5: Add compliance outcomes to Step 4 to determine the PAYG withholding gross gap.

    Step 1: Estimate salary and wages subject to withholding

    We start with external data on compensation of employees – salary and wages published by the ABS in its quarterly and annual national accounts. We adjust the data in the following manner:

    • We apply an uplift factor of 1.2% to account for the black economy. In arriving at this uplift factor, we considered comparable international uplifts and conducted an analysis of the large amount of data from our interactions with employers and our compliance activities that focus on the black economy.
    • We subtract benefits and payments not subject to withholding. This includes payments in kind (fringe benefits tax), salary sacrifice into superannuation, employee share schemes, and defence exempt income.
    • The resulting amount is assumed to represent salary and wages subject to withholding.

    Step 2: Calculate the theoretical PAYG withholding amount

    We multiply the amount calculated in Step 1 by the average rate of withholding to calculate the withholding amount that should be reported and remitted to us.

    The average rate of tax withheld is calculated from tax return data for each year. It is the amount of tax withheld, in respect of salary and wage income, over the total salary and wages type income.

    This provides us with the theoretical PAYG withholding amount that should be reported and remitted.

    Step 3: Calculate PAYG withholding received by the ATO

    Total PAYG withholding received is calculated from ATO systems data. It is calculated on an accrual basis. Non-resident dividends, interest and royalty withholding tax amounts are excluded.

    Next, we subtract other non-applicable amounts, namely non-salary and wage withholding amounts. These include personal services income for sole traders, tax withheld where an Australian business number (ABN) is not quoted, voluntary agreements, benefits and pensions. We are then left with PAYG withholding received minus excluded amounts.

    Step 4: Calculate the PAYG withholding net gap

    We subtract PAYG withholding received (calculated in Step 3) from the theoretical PAYG withholding amount (calculated in Step 2) and add non-pursuable debt amounts (PAYGW liabilities which have been written-off after being deemed as irrecoverable at law or not economical to pursue) to determine the net gap.

    Step 5: Calculate the PAYG withholding gross gap

    Add compliance outcomes and taxpayer self-adjustments to the PAYG net gap to determine the PAYG withholding gross gap.

    Some of the key assumptions of the methodology are:

    • when we remove identified income not subject to withholding from ABS Australian National Accounts data, the resulting amount represents salary and wages subject to withholding
    • the average rate of withholding we apply to this data is appropriate.

    This table displays the five-step PAYG withholding gap estimates (in dollar values) from 2010-11 to 2015-16

    Summary of estimation process ($ millions)

    Step

    2010–11

    2011–12

    2012–13

    2013–14

    2014–15

    2015-16

    Step 1

    Salary and wages

    601,482

    642,893

    664,879

    686,956

    705,725

    727,017

    Black economy uplift (1.2%)

    7,218

    7,715

    7,979

    8,243

    8,469

    8,724

    Earnings not subject to withholding

    27,884

    28,393

    26,793

    26,956

    29,065

    30,178

    Salary and wages subject to withholding (A)

    580,815

    622,215

    646,064

    668,243

    685,129

    705,563

    Step 2

    Average rate of withholding (B)

    23.1%

    23.7%

    23.7%

    23.9%

    24.7%

    24.9%

    Multiply (A) and (B) to calculate theoretical liability (C)

    134,177

    147,174

    152,890

    159,974

    169,177

    175,653

    Step 3

    Total PAYG withholding received

    130,001

    142,866

    150,210

    157,406

    166,793

    174,446

    Subtract excluded amounts

    1,167

    1,294

    1,343

    1,392

    1,611

    1,705

    PAYG withholding received minus excluded amounts (D)

    128,834

    141,572

    148,867

    156,014

    165,182

    172,741

    Step 4

    Non-pursuable debt (E)

    485

    459

    467

    436

    414

    444

    (C) minus (D) plus (E) to equal net gap (F)

    5,802

    6,069

    4,459

    4,373

    4,439

    3,356

    Step 5

    Add compliance outcomes and taxpayer self-adjustments to net gap (F)

    935

    749

    1,502

    1,374

    2,318

    2,964

    Equals gross gap

    6,737

    6,818

    5,960

    5,747

    6,757

    6,320

    Notes: The results provided in this estimate are to be considered preliminary due to being subject to revision in line with the national accounts datasets administered and revised by the ABS.

    Limitations

    Our data for salary and wages from tax returns does not have the same definition as the salary and wages series produced by the ABS. While we make adjustments to increase consistency, there are some items in the ABS data series we cannot quantify. The main variances are:

    • Individuals earning under the tax-free threshold are not required to lodge a return and while a significant number of people earning income under the threshold do lodge tax returns, we will be missing some wage and salary data which will affect the average tax rate we apply.
    • We do not have data on changes in provisions for future entitlements, such as long service leave.
    • While we have tax expenditure statement estimates for tax-exempt Australian Defence Force payments and allowances, this does not include the value of food, clothing and travel.
    • We are uncertain about the number of individuals that are under voluntary withholding agreements or labour hire arrangements where they are classified as employees.

    We use Australian National Accounts data to estimate theoretical salary and wages amounts. There are limitations with this approach which means that there will be a margin of error with the data. The limitations include:

    • sampling and non-sampling errors
    • national accounts data often subject to revision can vary historical trend results, so material revisions to this data will result in changes to the estimated PAYG withholding gap
    • non-measurement of the underground economy in relation to compensation of employees (COE) due to lack of sufficient data. This means the tax gap is likely to be underestimated (however we have added an estimated uplift for this, so it may differ from the actual).

    Definitions

    Top-down approach

    Top-down approaches use externally-provided aggregated data sources to estimate the size of the tax base, from which we estimate theoretical tax liability. The difference between the theoretical tax liability and the amount we receive is the estimated tax gap. A top-down approach is typically used for indirect taxes.

    Bottom-up approach

    Bottom-up approaches involve a detailed examination of data sources, such as tax returns, audit results, risk registers or third-party data-matching information. We then extrapolate the results to establish the extent of non-compliance across the whole population, from which we estimate the tax gap. This approach generally involves applying statistical techniques to estimate the incidence and value of non-compliance. A bottom-up approach is typically used for direct taxes.

    Compensation of Employees

    ABS Series 524 National Accounts is used to calculate salary and wages amounts. Compensation of employees is defined by 2008 System of National Accounts as '... the total remuneration, in cash or in kind, payable by an enterprise to an employee in return for work done by the latter during the accounting period'.

    The Compensation of Employees dataset consists of two main components:

    • wages and salaries (including paid in cash and in kind)
    • employer social contributions.

    The ABS produces a salary and wages (cash or in kind) series and an employer social contributions series as a part of the Compensation of Employees (National Accounts). Salary and wages include:

    • all cash payments (including penalty payments), all leave payments, supplementary allowances, bonuses, commissions, tips and gratuities, and payments remitted to a third party (such as income taxes)
    • the cost of goods and services provided by the employer to the employee or household (fringe benefits)
    • fringe benefits taxes
    • payments to defence force personnel, including the value of food, clothing and travel
    • changes in provisions for future entitlements, such as long service leave
    • payments to non-residents.

    Data sources

    To estimate the PAYG withholding gap we use a combination of ATO data and external data, such as:

    • ABS Compensation of Employees series and salary and wages (cash or in kind) series from the Australian System of National Accounts
    • ATO data relating to actual salary and wages withholding

    See also:

    Reliability assessment

    The PAYG withholding gap estimates are assessed to be of medium reliability. Data used to estimate the theoretical tax liability is largely based on external data sources and incorporates a factor for the black economy.

    However, there are some ongoing issues with Compensation of Employees data in recent years. This has been raised with the ABS by the ATO and Treasury.

    We continue to refine our work on the PAYG withholding gap in future releases.

      Last modified: 26 Oct 2018QC 57198