As part of our country’s tax system, Australian businesses must withhold a portion of payments made to employees or other entities and remit it to the Australian Taxation Office (ATO).
But how exactly do withholding tax obligations work, and does every small business owner need to do it? Let’s take a closer look at withholding tax for Australian residents and why you need to stay on top of it to protect your business.
What does it mean to withhold tax?
Withholding tax, or tax withheld, is the act of withholding a portion of income payments (e.g. wages or dividends) and paying that amount directly to the ATO on behalf of the recipient. The purpose of withholding tax is to ensure individuals and businesses pay their tax contributions throughout the financial year, avoiding a large tax bill at the end of the financial year.
For Australian business owners, the withholding tax system works under the Pay As You Go (PAYG) withholding framework. In short, businesses must withhold a portion of each employee’s salary or wages based on the employee’s tax file number (TFN) declaration, gross pay, and other relevant inclusions, such as the Medicare levy and any tax offsets.
PAYG is reported either monthly or quarterly on a business’s Business Activity Statement (BAS) or Instalment Activity Statement (IAS). The withheld amount is then credited to the employee when they lodge their tax return.
How does withholding tax work for small businesses?
For small business owners, withholding tax applies to the wages you pay your employees and other payments made to contractors (those deemed employees by the ATO). If you pay an employee or contractor, you are responsible for calculating the correct withholding amount using the taxable income tables provided by the ATO website. Withholding tax rates start above the tax-free threshold of $18,200 per year and increase for higher-income earners.
There are also rules for employees with student loans and non-residents. Students with HECS debt have additional amounts of tax withheld to cover their loan. For non-residents, withholding tax applies, while a different tax table is used, where 30% is withheld for every dollar earned up to $135,000.
Failure to withhold or remit payments, regardless of intent, will most likely result in penalties and extra charges.
Important note: As of 1 July, employers must pay superannuation contributions at the same time as salary and wages under the new Payday Super rules. Another change on 1 July 2026 is that the lowest income tax rate drops from 16% to 15%.
Is the Medicare levy part of PAYG tax withheld?
When running a business, the Medicare levy is also included in your PAYG. The Medicare levy is a 2% tax on top of withholding rates, used to fund Australia’s public health system, Medicare.
Keep all your documents and data in one place
Before calculating the withholding tax, you should collect and verify things like:
- Your employee’s tax file number declarations
- Contractor details
- Any declarations related to the tax-free threshold or salary sacrifice arrangements
Only with this paperwork can you know the correct withholding amount, as the individual’s circumstances and declared information will influence the marginal tax rate and other things that might impact how much tax should be withheld.
For payments made to someone who isn’t an Australian resident, such as foreign contractors or offshore banking units, you’ll need to consider any treaty country exemptions or reduced rates that might apply under international tax treaties. If this ends up being the case, the withholding tax is calculated differently, and you might need to call upon the services of a professional tax advisor.
What deductions can you (and your staff) make?
When income tax season rolls around, things can get stressful. But if you are worried about how to withhold tax or if your staff want to know how to get the most from their taxable income, you can share a few of these tips for deductions:
- Work-related expenses: Staff can claim deductions for work-related purchases like uniforms, tools, protective equipment, etc.
- Car and travel: If your employees use their own vehicles for work, they could be eligible to claim deductions for travel-related expenses on their income tax returns.
- Technology: Buying computers, software and other work-related tech might qualify as deductible tax offsets.
- Working from home deductions: If your small business employs staff who work from home, they might be able to deduct expenses like utilities and internet.
- Subscriptions: If you or your workers are members of professional associations and attend work conferences, they can usually be claimed as deductions.
Use an accountant or tax advisor
From managing different employees to specific voluntary agreements with certain staff members, withholding tax calculations can get complicated. This is especially true if your business regularly deals with contractors, non-residents or employees with difficult tax circumstances.
You’ll want to speak to a tax accountant or professional, or use payroll software, to ensure everything is accurate and complies with the ATO’s clear requirements. You can also use the ATO’s online resources, including tax withheld calculators and the income tax withholding guide, to figure out the correct withholding amounts for your situation.
