What Is Notional Tax? Notional Tax Definition (ATO)

Notional tax is “the tax that would have been payable on your business and/or investment income in your latest income tax assessment based on current income tax rates.”[1]

Right, so what does that mean?

The word notional means something that doesn’t exist. So a notional tax is a theoretical tax. A tax that you pay in theory.

So what is the ATO’s theory?

The ATO will calculate the tax payable only on your business and/or investment income (excluding capital gains). The ATO will ignore income earned from your salary or job and will apply the tax rates to only your business and/or investment income.

Do not be confused here, the notional tax figure does not reflect any GDP growth adjustments that take place for quarterly PAYG instalment amounts.

Example

George gets paid a salary by his employer of $75,000 p.a. which his employer withholds tax on. He also holds some share investments and owns a small business as a sole trader that in total provide him with a taxable income of $10,000 p.a.

  • George’s salary: $75,000
  • George’s business and investment taxable income : $10,000

Each year when George submits his tax return the ATO will calculate the notional tax for just his business and investment income. The ATO will calculate the notional tax by ignoring George’s salary and will look solely at the business and investment income of $10,000.

For George’s tax return for the 2010/2011 financial year the ATO applies the 2011/2012 tax rates to his business and investment income and calculates his notional tax as $600.[2] George meets the criteria for being registered in the PAYG instalment system and must make PAYG instalments. [3]

Now recall that the notional tax is a theoretical tax. In our example it is calculated purely to see if George meets the PAYG instalment criteria. In reality because George’s business is set up as a sole trader and his share investments are held in his name, the income will be added to his salary to calculate his actual tax liability. Assuming no further deductions George’s total taxable income will be $85,000 and his tax liability for 2010/2011 will be $20,675. [2] George’s employer already paid part of the tax as part of the PAYG withholding system. George has to make up the difference.

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[1] PAYG instalments – fact sheet for individuals, ATO, 2011

[2] Income Tax Calculator

[3] Who Has To Pay PAYG Instalments?

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