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 the ATO under the pay as you go (PAYG) withholding scheme to do so.
This system allows employees to better meet their expected end-of-year tax liabilities, including but not limited to Higher Education Loan Program repayments and Medicare payments.
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 by us for a defined period, typically a financial year.
A gap can arise from a number of taxpayer behaviours and can be either intentional or unintentional. Generally, this can be divided into two areas:
- non-reporting, including failure to register or failure to lodge
- under-reporting which ranges from unintentional mistakes, unreported cash transactions, engagement in tax avoidance activities, to fraud and illegal activities.
The key external data is from the ABS. The ABS Series 5204 National Accounts is used to calculate theoretical total PAYG withholding amounts. We also use this data to estimate theoretical salary and wages amounts.
Treasury's Tax Expenditure Statements are also used to identify defence force exempt income and ATO data is used to identify actual PAYG withholding amounts.
We assume that:
- when we remove identified income not subject to withholding from ABS 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.
We use a top-down methodology to estimate the PAYG withholding gap. This compares the following for a financial year:
- total individuals income tax withholding minus non salary and wages withholding, as reported to us on an accruals basis
- theoretical PAYG withholding from salary and wages calculated using external economic data.
We use external data on compensation of employees – salary and wages published by the ABS in its quarterly and annual National Accounts. Applying an average tax rate to the ABS salary and wages data gives us a theoretical PAYG withholding tax amount. The difference in percentage terms is assumed to represent the PAYG withholding gap.
To estimate theoretical PAYG withholding liability, we:
- Determine the amount of salary and wage payments in Australia from ABS National Accounts data.
- Subtract income 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.
- Multiply this amount by the average rate of withholding to calculate the withholding amount that should be reported and remitted to us.
To estimate the PAYG withholding gap, we:
- Determine the PAYG withholding accrual figures from ATO systems data, excluding non-resident dividends, interest and royalty withholding tax amounts.
- Subtract other 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.
- Add amounts for PAYG withholding liabilities that are irrecoverable at law or not economical to pursue.
- Subtract this amount from the theoretical PAYG withholding liability to estimate the withholding gap.
ATO salary and wages values are those from tax returns, though we make adjustments to include other items in the ABS series where possible. For fringe benefits value, we use the ABS payments in kind series from 2007–08. Fringe benefit data before 2007–08 has been derived using the year-on-year growth in the value of reportable fringe benefits from the tax returns.