What counts and what does not
The test is ordinary income with no tax collected on it yet. Employer withholding already covers wages, so they stay out; GST is collected through the BAS, so it stays out; capital gains are statutory rather than ordinary income, so they stay out of the base too.
Counts as instalment income
- Sole trader and partnership business income, GST-exclusive
- Rent from investment properties
- Interest and dividends
- Trust distributions
Does not count
- Salary and wages already under PAYG withholding
- Capital gains (the tax on them still arrives at assessment)
- GST collected on sales
- Exempt income
The figure matters twice: crossing $4,000 of instalment income in a lodged return is one of the triggers that pulls you into the system, as covered in the PAYG instalments guide, and it is the base your quarterly payments are calculated on once you are in.
Instalment income vs taxable income
Instalment income is a gross figure: business takings and investment receipts before any deductions. Your final tax is assessed on taxable income, which is that gross minus expenses. The gap between the two is why instalments rarely match the final bill to the dollar. The rate the ATO gives you already builds in last year's relationship between gross income and tax, so applying it to this year's gross gets close, but a year with unusually high expenses will over-collect and a lean-cost year will under-collect. The correction happens at assessment, where every instalment paid is credited against the tax on taxable income.
Notional tax
Notional tax is the ATO's estimate of the tax you will owe on this year's instalment income. It is built from your last lodged return: the tax on last year's instalment income, recalculated at current rates and uplifted by a GDP growth factor. Notional tax is the figure behind both instalment options on your notice: divided by four it produces the quarterly instalment amount, and divided by instalment income it produces the instalment rate.
How the instalment rate is derived
The rate on your notice is notional tax divided by instalment income, expressed as a percentage. It is an average rate, not your marginal bracket. As an illustration on 2026-27 resident rates: a sole trader whose only income is $80,000 of business profit pays about $16,120 in tax and Medicare levy, so the equivalent rate would be around 20.2%. An actual notice derives the percentage from your last return with the GDP uplift applied, so it lags your current income by a year or more. Each quarter you multiply the rate by that quarter's actual instalment income, which is why the rate method tracks a variable income better than the fixed amount. The PAYG instalment calculator runs both views on your own figures, and the surrounding vocabulary, from taxable income to marginal rates, is defined in the glossary.
Sources
Narelle Hartigan is a CPA-qualified tax accountant with over a decade of experience in Australian personal taxation and payroll. She founded PAYG Calculator Australia to make tax withholding easy for every Australian worker to understand.