Most employees have tax withheld at the standard rate from the tax tables, and for most of them that’s fine. But sometimes the standard rate doesn’t match what someone will actually owe at year end. A real estate agent with a negatively geared property, a sales rep whose car allowance is fully deductible, or a retiree with investment income on top of a pension can all end up with too much or too little tax coming out of each pay.
That’s what a PAYG withholding variation is for. It lets the ATO (or in some cases the employee) set a different rate or amount of withholding so the tax taken during the year sits closer to the final liability.
For payroll teams, variations are mostly a matter of timing and paperwork: knowing when you can act, what the ATO notice actually covers, and what to do when it expires or the employee moves on. Here’s how the process works now, plus the questions we hear most often on the helpline.
What is a PAYG withholding variation?
A withholding variation changes the amount of tax you withhold from a specific employee’s pay, replacing the standard tax table rate with a rate or amount set for their circumstances.
There are three types you’ll come across in payroll.
Downward variation reduces the tax withheld. The employee applies to the ATO, and you can’t reduce their withholding until the ATO sends you an official variation notice. This is the one most people mean when they talk about a “tax variation”.
Upward variation increases the tax withheld. The employee doesn’t need ATO approval for this. They ask you in writing, in any format that suits your business, and you withhold the extra amount using Schedule 14. Employees can also arrange this through a withholding declaration in ATO online services.
Class variation is a downward variation that an employer applies for on behalf of a group of six or more employees who all receive the same allowance for the same purpose, where the expense is expected to be deductible. Fewer than six, and each employee applies individually.
How does an employee apply for a downward variation?
Employees lodge the PAYG withholding variation application with the ATO, not with you. The main options are:
- Online through myGov: Sign in, go to ATO, then Tax, Manage, PAYG withholding variation.
- Through a tax agent: Agents lodge via Online services for agents under Lodgments, then Client forms.
- On paper: Only if online isn’t possible. The paper form is NAT 2036 (or the short form NAT 5425 for allowances and study and training support loans), ordered through the ATO’s publications service or by phoning 13 28 65.
The ATO aims to process online applications within 28 days and paper applications within 56 days, longer if it needs more information. That’s a useful thing to tell employees who ask why their pay hasn’t changed yet.
There are a few things employees get wrong that slow the process down: entering the employer’s ABN with spaces, giving the wrong address for the pay office (where payroll is processed, not where they work), and leaving out income from other payers. Before they apply, it’s worth checking that you hold their correct TFN, since the ATO won’t process the application without it.
When can they apply?
Applications can be lodged at any point in the year up to 30 April. A variation is valid for one financial year. Applications lodged in May or June apply to the coming financial year, starting 1 July.
The ATO can issue multi-year variations for allowances. The notice will say if that’s the case.
What the ATO checks before approving
The ATO will only process a downward variation if the employee has lodged all required tax returns and activity statements, has no outstanding tax debt, and didn’t end up with a debit assessment last year while already on a variation. Approval also doesn’t mean the ATO has accepted the deductions in the application. The actual liability is worked out when the employee lodges their return.
What happens when the variation is approved?
The ATO sends a letter to the employee and a notice of withholding variation to each payer listed on the application. The notice is specific. It will state:
- your business name and ABN
- the employee’s name
- the varied rate or amount of tax to withhold
- the payment types it applies to (salary and wages, bonuses, overtime, allowances and so on)
- the expiry date
There are two rules to build into your process:
- Check the notice is addressed to you and correctly identifies the employee before you act on it.
- Apply the varied rate only to the payment types listed. If the notice covers salary and overtime but the employee also receives a bonus, the bonus is taxed at the normal rate under Schedule 5. Salary sacrifice amounts aren’t subject to the varied rate either.
The variation takes effect from the next available payday after you receive the notice. If you receive more than one notice for the same employee, the most recent one supersedes all earlier notices. Keep a copy with your business records for five years.
When does a PAYG variation expire, and how is it renewed?
The variation ends on the date shown on the notice. There’s no automatic rollover. If the employee wants it to continue, they need to lodge a new application at least six weeks before the expiry date, and you go back to the standard tax tables from the next payday after expiry until a new notice arrives.
The ATO can also withdraw a variation before its expiry date. Only the ATO can do this, so if an employee wants to cancel their variation they need to write to the ATO at the address on their approval letter. If you receive a withdrawal notice, stop applying the varied rate from the next available payday.
Employees also need to lodge a new application if their circumstances change during the year, for example if they sell the rental property that justified the variation.
How do class variations work?
If six or more employees receive the same allowance and it’s reasonable to expect they’ll spend at least that amount on deductible expenses, you can apply for a class variation on their behalf rather than each of them applying individually.
You apply by letter on company letterhead to the ATO at PO Box 3010, Penrith NSW 2740. The letter needs to cover the nature of the business, the type and amount of the allowance and the expense it’s meant to cover, a declaration of the proportion spent on business use, the names and TFNs of the employees, their basis of employment and duties, and the total number of employees covered.
You’re responsible for the accuracy of the information on behalf of everyone included, so it’s worth being confident in the deductibility before you lodge.
Helpline questions about PAYG variations
These come up often enough that they’re worth answering directly.
I received a variation letter from the ATO on 16 July for an employee I’d already paid on 15 July. Do I need to go back and adjust the tax?
No. There’s no requirement to backdate a variation. It applies from the next available pay after you receive the notice, and you can’t reduce withholding before that point.
An employee has started with us part way through the year and has a variation letter from their previous employer. Can we use it?
No. A variation is issued for a specific payer and ABN. The employee needs to lodge a new application listing your business, and you withhold at the standard rate until the ATO sends you a notice.
An employee with a variation is being terminated next pay. Does the variation apply to their termination pay?
Generally not. The variation only applies to the payment types listed on the notice, and termination payments are usually excluded. Check the notice. If termination payments aren’t specifically named, tax them as you normally would, including any ETP components.
An employee on a variation is about to receive a bonus. Do we apply the varied rate?
Only if the notice specifically includes bonuses. The employee needs to have included the bonus in their application for that to happen. If bonuses aren’t listed, withhold at the normal rate for bonus payments using Schedule 5.
An employee wants more tax taken out, not less. Do they need to apply to the ATO?
No. That’s an upward variation, and it only needs a written request from the employee to you. This also comes up in years with 27 fortnightly or 53 weekly pays, when the standard tables can under-withhold. You should let affected employees know so they can ask for an additional amount if they want to.
An employee wants to cancel their variation early. Can we just switch them back to the tax tables?
Not on their say-so. Only the ATO can withdraw a variation notice. The employee writes to the ATO, and you revert to the tables once you receive the withdrawal notice.
Keeping variations under control in payroll
The recurring problems with variations are almost always about timing: a rate applied before the notice arrived, a rate still running after the expiry date, or a varied rate applied to a bonus or termination payment it never covered. A simple register of active variations with their expiry dates and covered payment types catches most of this.
If you’d rather not track it at all, that’s the kind of detail a managed payroll service handles as part of processing each pay. Get in touch if you’d like to talk it through.