How much to set aside for tax: GST, VAT and income tax, with an example

Short answer: set aside three things, not one. (1) The GST or VAT inside every payment you receive, less the GST or VAT on your purchases: 1/11 of GST-inclusive takings in Australia, 3/23 in New Zealand, 1/6 of takings at the UK 20% standard rate. (2) Tax you withheld from wages (PAYG withholding or PAYE). (3) Income tax on your profit: the simplest guide is last year’s tax bill divided by last year’s profit, applied to this year’s profit as it comes in; with no history, a company can start from the company tax rate (25% for most small Australian companies, 28% in New Zealand, 19% to 25% in the UK) and a sole trader should ask their accountant for a percentage. Move it into a separate savings account every week or every time you are paid. None of it is yours, even though it sits in your bank account until the due date.

The three pots

Pot	How much	When it is due
GST or VAT	Tax on sales less tax on purchases. AU 1/11 and NZ 3/23 of GST-inclusive amounts; UK 1/6 of amounts including 20% VAT	With each BAS, GST return or VAT return (monthly, two-monthly or quarterly)
Tax withheld from wages	What each payslip shows as tax withheld	Monthly or quarterly (AU, on the BAS), monthly or twice monthly (NZ), monthly or quarterly (UK)
Income tax on profit	Last year’s tax ÷ last year’s profit, or the company rate to start	AU PAYG instalments, NZ provisional tax, UK payments on account, then the balance after the return

The first two are other people’s money passing through your account: customers paid the GST or VAT, and staff earned the wage tax. The third is a share of your profit, and it is the one owners most often forget because nothing is due for months.

A worked quarter: an electrical company in Brisbane

These figures are made up. A small electrical company (a base rate entity, so company tax is 25%) is registered for GST on the accruals basis and every invoice has been paid. One quarter:

Line	Amount
Sales received, including GST	110,000
Materials, van, rent and other costs paid, including GST	55,000
Wages (gross)	25,000, of which 3,800 is tax withheld
Super at 12%	3,000
Profit for the quarter (100,000 − 50,000 − 25,000 − 3,000)	22,000

What to set aside:

Pot	Working	Amount
GST	110,000 ÷ 11 = 10,000 collected, less 55,000 ÷ 11 = 5,000 paid	5,000
Wage tax withheld	From the payslips	3,800
Company tax	22,000 × 25%	5,500
Total		$14,300

The bank balance went up by $30,800 over the quarter (110,000 in, less 55,000 of costs, 21,200 of net wages and 3,000 of super). $14,300 of that, 46.4%, is owed to the ATO. The money that is really the business’s is $16,500, which is exactly the profit after company tax. Set aside 13% of every deposit (14,300 ÷ 110,000) and the pot fills at the same pace as the bill grows.

The company’s PAYG instalments are set by the ATO from its last return, so the quarterly instalment may be more or less than $5,500. Set aside what you will actually owe, not just the instalment: if profit has grown, the difference turns up as a bill after the return is lodged. The BAS report guide shows how the GST and wage tax figures come out of Xero.

Working out your own percentage

1. GST or VAT: if almost all your sales carry tax, set aside 1/11 (AU), 3/23 (NZ) or 1/6 (UK, standard rate) of each receipt, then let the purchase credits come back to you as a smaller bill. On the UK Flat Rate Scheme, or with zero-rated or GST-free sales, use your own return: last quarter’s tax paid ÷ last quarter’s takings. Not registered yet in the UK? The VAT threshold calculator shows when your rolling 12 months of sales will pass £90,000, so you can start the pot before the first VAT quarter.
2. Wage tax: move the withheld amount on each payday, so it never looks like spare cash.
3. Income tax: take last year’s income tax bill (not counting GST or VAT) and divide it by last year’s net profit. If it was $15,000 on $60,000, set aside 25% of each month’s profit. Recheck when profit changes a lot, because tax rates for individuals rise with income. A UK limited company can work out its rate directly: the corporation tax calculator gives the 19%, 25% or marginal relief figure and the amount to put aside each month.
4. Add them up as a share of takings, as in the example above, so one transfer covers everything.

The first-year trap

The first tax bill is often bigger than owners expect, because the instalment systems start late and then catch up.

• UK sole traders and partners: once a Self Assessment bill is over £1,000 (and less than 80% of your tax was taken at source), HMRC asks for payments on account: half of last year’s bill on 31 January and half on 31 July, towards the current year. In the first January you pay the whole of your first year’s bill and the first payment on account at once. A first-year bill of £6,000 means £9,000 due on 31 January, then £3,000 on 31 July. Above £50,000 of turnover you also have to report quarterly instead of annually: Making Tax Digital for Income Tax covers the thresholds and dates.
• New Zealand: once your residual income tax is over $5,000, you pay provisional tax for the next year. On the standard option it is last year’s tax plus 5%, in three instalments (28 August, 15 January and 7 May for a 31 March balance date). In the year you first cross the threshold, the terminal tax for that year and the first instalments for the next can fall close together. Provisional tax in NZ works the dates and a growing year through.
• Australia: the ATO usually enters you into PAYG instalments after your first return with business income, so the first year’s tax is paid in one go after the return, and instalments for the current year start soon after. PAYG instalments explains option 1 and option 2 and works a growing year through.

Owners who set aside from the first invoice have the money. Owners who wait for the first bill pay a year and a half of tax from one year of cash.

Where Xero shows what you owe

1. GST or VAT so far: the Balance Sheet shows the GST (AU, NZ) or VAT (UK) liability account. Between returns, it grows with each sale and shrinks with each purchase. The Activity Statement (AU), GST Return (NZ) or VAT Return (UK) shows the period’s figures (what each box on the Xero VAT return means; the NZ GST return in Xero).
2. Wage tax: the PAYG Withholdings Payable account (AU), or the PAYE liability account in UK and NZ payroll, on the Balance Sheet.
3. Income tax: Xero does not work out income tax during the year. The Net Profit on the Profit and Loss is before income tax, and the tax usually only appears when your accountant posts it at year end (profit before tax explains). Multiply year-to-date net profit by your percentage to see what should be in the pot.
4. The tax savings account itself: add it to Xero as a bank account and record each transfer as a transfer between your own accounts, not a payment, so profit does not change.

The gap between what you owe and what is in the bank is the core of profit in Xero but no cash in the bank, and how much can I pay myself takes the tax pot off before working out your drawings or salary. If you run Profit First, with a tax account alongside profit, pay and running costs, the Profit First calculator shows the percentages your figures support today and how to split each deposit.

Common mistakes

• Treating the bank balance as spendable. GST, VAT and wage tax inside it are owed already.
• Growing past the GST threshold without noticing. In Australia, once GST turnover reaches $75,000 you owe GST from then on even if your invoices do not include it (when you must register for GST).
• Setting aside a share of takings for income tax. Income tax is on profit, not sales. 25% of takings is far more than 25% of profit for most businesses.
• Using the instalment as the bill. Instalments are based on last year. If profit has grown, the rest arrives after the return.
• Forgetting the first-year catch-up (payments on account or provisional tax starting).
• Spending the pot when a quarter is tight. That turns a cash squeeze into a tax debt, with interest or penalties. If it has already happened, see what to do if you can’t pay your BAS, GST or VAT on time.

Common questions

What percentage should I set aside for tax? Work it out in three parts: the GST or VAT on your sales less the GST or VAT on your purchases, the tax withheld from wages, and income tax at last year’s tax divided by last year’s profit. In the worked example above that came to 13% of every deposit.

How much should a sole trader set aside for tax? Take last year’s income tax bill and divide it by last year’s profit, then set that share of each month’s profit aside, plus any GST or VAT you collected. In the first year, ask your accountant for a percentage, because personal tax rates rise with income and there is no history to go on.

Should I set aside tax on turnover or profit? Income tax is charged on profit, so set aside a share of profit for it. GST or VAT is different: it is part of each sale, so set aside the tax portion of every payment you receive, less the tax on your purchases.

How much GST should I put aside? In Australia, one dollar in every eleven of GST-inclusive sales, less one in eleven of GST-inclusive purchases. In New Zealand the fraction is three in twenty-three. For UK VAT at the 20% standard rate it is one sixth.

Why is my first tax bill so big? In the UK, the first 31 January payment covers the whole first year plus half of the next year in advance. New Zealand provisional tax and Australian PAYG instalments start in a similar way, so the first bill can cover more than one year.

Where can I see how much GST I owe in Xero? On the Balance Sheet, in the GST or VAT liability account, and for a finished period on the Activity Statement, GST Return or VAT Return. Xero does not calculate income tax during the year.

See your cash against what is coming up, every Monday

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