Got a PAYG instalment notice from the ATO and are wondering why you have to pay tax before you lodge your next tax return? Notional tax is not a new tax. It is the ATO’s estimate of the income tax you are likely to owe for this financial year, based largely on your most recent tax return.
This estimate is used by the ATO to work out your quarterly PAYG instalments (Pay As You Go), so you pay your expected tax bill in smaller amounts throughout the year, rather than one big sum at tax time.
In this guide, we explain what notional tax is, how the ATO calculates it, who has to pay PAYG instalments and what you can do if your income has changed and the ATO’s estimate no longer reflects your situation.
What Do You Mean By Notional Tax?
Notional tax is the income tax the ATO expects you to pay every year, based on your last lodged tax return. It’s a forecast, not a bill for money you owe right now.
That distinction matters. A tax bill is fixed and final; notional tax is a moving estimate, reconciled against your actual tax payable once you lodge. Overpay through instalments and you get a refund; underpay, and you settle the difference.
Let’s define “notional tax” as simply as possible: it’s an estimate, recalculated every income year, that exists purely to set your instalment amount. Some ATO paperwork refers to it as “notional income tax,” which is the same figure but with a different label.
Notional Tax vs. Actual Tax
“Notional” means estimated, not fixed. Notional tax is the ATO’s best guess at your liability, built from last year’s numbers and adjusted for expected growth.
Actual tax is the real amount you owe once you lodge and the ATO assesses your genuine income and deductions for that year. When you lodge, every instalment you’ve paid is subtracted from that final bill. Overpay and you’re refunded; underpay and you settle the balance.
Not sure whether your PAYG instalments are accurate? Our tax advisors can review your notional tax, explain your PAYG obligations, and help you vary your instalments if your income has changed. Contact ISM Accountants today for expert tax advice.
How Does the ATO Calculate Notional Tax?
The ATO calculates notional tax from two inputs: your previous year’s tax payable and a statutory GDP adjustment factor applied to reflect expected economic growth. This is the process behind every PAYG instalment notice, whatever your entity type.
What feeds into it:
- Previous year’s taxable income and tax payable the starting point
- GDP adjustment factor a legislated uplift, set annually
- Legislative basis under the Taxation Administration Act 1953
- Why it shifts yearly: both your income and the adjustment factor change each year
That’s how the ATO calculates notional tax in a nutshell: last year’s number, adjusted upward. Nothing about your actual current-year income enters the calculation unless you lodge a variation. Some ATO correspondence and accounting software still label this figure as “notional income tax” it is the same calculation but with a different name.
The 2026–27 GDP Adjustment Factor: 5%
The GDP adjustment factor tracks movements in Australia’s gross domestic product over the previous two calendar years, and it’s set annually by legislation. For the 2026–27 income year, it’s 5%, applying to instalment quarters starting on or after 1 April 2026.
Taxpayers with a substituted accounting period starting in January, February, or March 2026 stay on the prior year’s 4% rate, since their year began before the new one took effect. This factor alone is often the biggest driver of year-on-year movement in your notional income tax estimate, even if your income hasn’t changed much.
The Formula & A Worked Example
Notional Tax = Previous Year’s Tax Payable × (1 + GDP Adjustment Factor)
That’s how the ATO works out notional tax as a formula. Worked example for 2026–27:
- Previous year’s tax payable: $50,000
- GDP adjustment: 5%
- Notional tax: $50,000 × 1.05 = $52,500
- Quarterly installment: $52,500 ÷ 4 = $13,125
That’s what lands on your activity statement each quarter, if you’re on the instalment amount method. It won’t move on its own if your circumstances change mid-year, you’d need to vary it.
Why Does the ATO Use Notional Tax?
It uses a notional tax to assist taxpayers to pay their income tax over time rather than have one large tax bill at the end of the financial year. PAYG instalments can be paid quarterly, which may help you manage your cash flow and meet your tax obligations.
Also, the PAYG instalment system helps:
- Lower your chances of getting a big, unexpected tax bill at tax time
- Make it easier to pay taxes throughout the year
- Timely and regular payment of taxes
- Cut the outstanding tax debt throughout the tax system
Your quarterly PAYG instalments are calculated on the ATO’s estimate of your annual tax liability. When you submit your tax return, the ATO compares the instalments you’ve already paid with your actual tax liability. You might receive a refund if you paid too much. If you paid too little, you’ll need to pay the difference.
Who Has to Pay Notional Tax? (PAYG Eligibility Thresholds)
You may need to pay notional tax if you meet the Australian Taxation Office (ATO) thresholds for the PAYG instalment system. Eligibility depends on your taxpayer type and the amount of tax or business income reported in your previous tax return.
Taxpayer | Eligibility Criteria |
Individuals & Trusts | Business/investment income of $4,000+, tax payable of $1,000+, or notional tax of $500+ |
Companies & Super Funds | Instalment income of $2 million+, or notional tax of $500+ |
If your tax return meets any of these thresholds, the ATO will automatically enroll you in the PAYG instalment system. You don’t need to apply or opt in. Instead, the ATO will send you a PAYG instalment notice explaining how much you need to pay and when.
So, do you have to pay notional tax? If your most recent tax return exceeded one of the eligibility thresholds above, the answer is likely yes. In simple terms, notional tax eligibility is triggered as soon as you meet any one of the ATO’s PAYG thresholds.
If your books aren’t current enough to know which option suits you, ISM’s bookkeeping services keep your BAS and IAS figures accurate quarter to quarter.
How PAYG Instalments Work
PAYG instalments let you pay your estimated income tax in quarterly amounts instead of one large payment when you lodge your tax return. The ATO calculates these instalments using your notional tax and sends you a payment notice each quarter.
If you’re registered for GST, your PAYG instalments are included in your Business Activity Statement (BAS). If you’re not registered for GST, you’ll receive an Instalment Activity Statement (IAS) instead.
The ATO will generally give you two payment options:
- Pay the instalment amount calculated by the ATO.
- Pay using the instalment rate, where you apply the ATO’s rate to your actual business or investment income for the quarter.
Quarter | Due Date |
Q1 | 28 October |
Q2 | 28 February |
Q3 | 28 April |
Q4 | 28 July |
Paying these instalments throughout the year helps spread your tax payments and reduces the chance of facing a large tax bill when you lodge your annual tax return.
If your books aren’t current enough to know which option suits you, ISM’s bookkeeping services keep your BAS and IAS figures accurate quarter to quarter.
Is There a Notional Tax Calculator?
No. The ATO does not offer an official notional tax calculator. The ATO calculates your notional tax automatically using your most recent tax return and includes the amount on your PAYG instalment notice.
While third-party calculators can provide estimates, they are not official and should only be used as a guide. If your income has changed significantly, you can vary your PAYG instalments instead of relying on an estimate.
Can You Change Your Notional Tax? (The Variation Process)
You can vary your instalments if you reasonably expect your actual tax to differ from the estimate. Common triggers: a business downturn, retirement, losing a major client, rising costs, or lower investment income.
- Log in to ATO Online Services (or have your tax agent do it)
- Select the option to vary your instalment amount or rate
- Enter a supportable revised estimate for the full income year
- Keep documentation behind the figure
- Submit before that quarter’s due date variations apply from the quarter you lodge
Getting the wording and figures right matters, since a wrong estimate risks the GIC trap below. ISM’s tax return services team can lodge it correctly the first time.
What If Your Estimate Is Wrong? (The GIC Penalty)
Vary down, and if your actual liability ends up more than 15% higher than what you paid, the ATO can apply the General Interest Charge (GIC) on the shortfall back to each installment. due date. Overestimate instead, and there’s no penalty; any surplus is credited or refunded once your return is assessed. If you’re unsure, erring high is the safer mistake.
Notional Tax vs. Actual Tax vs. PAYG Instalments
Feature | Notional Tax | Actual Tax | PAYG Instalments |
Purpose | Estimate future tax | Final tax liability | Quarterly prepayments |
Based On | Previous year’s return | Current year’s income | Notional tax estimate |
Paid Directly? | No | Yes | Yes |
In simple terms:
- Notional tax is the ATO’s estimate of what you may owe.
- PAYG instalments are the quarterly payments you make based on that estimate.
- Actual tax is the final amount calculated when you lodge your tax return. Any difference is either refunded to you or paid as a balance owing.
Common Mistakes Businesses Make
- Ignoring PAYG instalment notices instead of reviewing what they mean
- Missing BAS or IAS deadlines
- Not varying instalments when income genuinely falls
- Guessing an estimate without records behind it
- Assuming notional tax is an extra tax, not a prepayment
- Forgetting the GDP adjustment factor changes yearly
- Letting bookkeeping lapse, making an accurate variation impossible
Most of the confusion Australian businesses face around PAYG installments is due to these habits, not the underlying rules.
Final Thoughts
Notional tax is an ATO estimate, not an extra bill. It exists to spread your income tax across the year through PAYG instalments, rather than leaving you with one large payment at lodgment. That’s PAYG instalments explained about as plainly as it gets.
Reviewing your estimated position regularly, rather than just paying whatever the notice says, is what keeps you clear of unnecessary GIC. It’s also the simplest way to keep tabs on do I have to pay notional tax at the same rate every quarter, since the answer can change once you vary.
If your circumstances have changed since your last return, it is worth discussing a variation before you simply pay what is on the notice.
Unsure whether your PAYG instalments still reflect your actual income? Book a free consultation with ISM Accountants for straightforward, PAYG instalments Australia-specific advice on notional tax, variations, and cash flow planning.
Frequently Asked Questions
Notional tax is the ATO’s estimate of your current year’s income tax, based on your most recently lodged tax return. The ATO uses this estimate to calculate your PAYG instalments, which are later reconciled against your actual tax liability when you lodge your next return.
The ATO uses your previous year’s tax payable, applies the GDP adjustment factor, and divides the estimated amount into quarterly PAYG instalments. These payments are credited toward your final tax bill when you lodge your tax return.
The ATO calculates notional tax by taking your previous year’s tax payable and applying the current GDP adjustment factor. For example, if your previous tax payable was $50,000 and the GDP adjustment factor is 5%, your notional tax becomes $52,500.
You only pay notional tax if you are enrolled in the PAYG instalment system. If your previous tax return meets the ATO’s eligibility thresholds, you will automatically receive a PAYG instalment notice. If your expected income changes, you can apply to vary your instalments.
You may be required to pay PAYG instalments if you meet the ATO’s thresholds:
- Individuals and trusts: Business or investment income of $4,000+, tax payable of $1,000+, or notional tax of $500+.
- Companies and super funds: Instalment income of $2 million+, or notional tax of $500+.
The GDP adjustment factor is the percentage that the ATO applies to your previous year’s tax payable to estimate your current year’s tax. It reflects expected economic growth and is updated each financial year. For 2026–27, the GDP adjustment factor is 5%, up from 4% the previous year.
