What are payments on account?

With HM Revenue and Customs awaiting payment of many individuals second payment on account of tax due on 31st July, we look at exactly what are payments on account.

The system was implemented as a way of helping the self-employed ease the burden of their annual tax bill which was due 31 January each year by staggering the payment throughout the year.  The idea of payments on account can be a cause of confusion and frustration for many who are expected to pay tax via self-assessment.

Payments on account are advance contributions towards your self-assessment tax liability.  The liability is paid in two instalments, one on 31st January (which is the same date as the ‘balancing payment’ and will be explained later) and the other on 31st July.

The amount due is calculated by looking at your previous year’s tax liability and worked out as half the previous year’s tax and class 4 National Insurance liability.  Any student loan repayments, capital gains tax or class 2 National Insurance contributions are not included.  These are paid as part of your balancing payment instead.

Payments on account are not optional.  You are automatically enrolled when your self-assessment tax return is submitted.  The only exceptions are those who have a tax liability less than £1,000 per annum or 80% or more of your tax liability was paid at source, e.g. through Pay As You Earn (PAYE).

Your first year with Payments on Account

One of the most confusing and difficult aspects of the payment on account system is the first year under the scheme.  The first time an individual will make a ‘payment on account’ HM Revenue and Customs will expect for you to pay 150% of your tax liability at once.  This is illustrated below:

  • You owe £8,000 in tax on earnings between 6 April 2016 and 5 April 2017.
  • The payment will need to be paid to HM Revenue and Customs by 31 January 2018 which settles the liability for the 2016/17 tax year. If this payment is paid late, interest will be charged upon late payment.
  • Under the payment on account system, HM Revenue and Customs would look at your tax liability for the 2016/17 tax year (£8,000) and would therefore expect a payment on account for the 2017/18 tax year of £4,000 on 31 January 2018. This would mean that on 31 January 2018, you would be expected to pay a total of £12,000 to HM Revenue and Customs.
  • A further payment of £4,000 would be payable to HM Revenue and Customs on 31 July 2018.
  • If your earnings were higher than expected and you haven’t paid enough tax, then you must pay anything you owe by 31 January 2019. This is known as the balancing payment.  The balancing payment is made together with the first payment on account of the 2018/19 tax year.

As you can see from the above, on 31 January 2018, you are not only paying your tax liability for the 2016/17 tax year, you are also paying 50% of the estimated tax for the 2017/18 tax year.  If you are not aware of this, it could come as quite a shock as you may not have budgeted for this payment and do not have the funds to pay.

One of the reasons why it is always advisable to submit your tax return as early as possible is due to the payment on account system.  By completing your tax return earlier, it allows an individual to understand what their tax liability will be so that they can budget to meet the liability.  This is particularly important in the first year when there is a higher than usual tax liability due to the Payment on Account.

Fluctuating Incomes

Due to the nature of any business, you may find that income can fluctuate from year to year.  This is where problems can arise when it comes to payments on account.

If profits fall and your payment on account is higher than your tax liability, you can ask HM Revenue and Customs to reduce your payments on account to bring it in line with what you will actually owe.  This can be done by way of form SA303, which lets you state that your tax liabilities are down.  If you have already paid more than what you owe, HM Revenue and Customs will simply refund you this amount.

You should only do this however if you are sure your profits are down or there is another legitimate reason why your tax liability is going to fall.  You should not apply to reduce your payment on account simply because you cannot afford to pay what is due.  IF you reduce your payment on account by too much, HM Revenue and Customs will charge interest on the shortfall and apply further penalties for underpaying your tax.

The balancing payment

If, however your income fluctuates the other way, meaning your tax liability is more than was previously estimated, you will be required to make a ‘balancing payment’ to bring your account up to date.  This will be due by 31st January next year.

In the above illustration, we anticipated that £8,000 of tax would be payable for the 2017/18 tax year and this was paid on 31st January and 31st July.  If, when the final tax liability was calculated, the total tax due was £10,000.  This would be made up as follows:

  • £4,000 paid 31st January 2018 (first payment on account)
  • £4,000 paid 31st July 2018 (second payment on account)
  • £2,000 paid 31st January 2019 (balancing payment)

On 31 January 2019, not only would you be paying the £2,000 balancing payment but you are also payment the first payment on account of the 2018/19 tax year.  This would mean that on 31 January 2019, you are paying a total of £7,000 to HM Revenue and Customs.

Payments on account are without doubt one of the most complicated and contentious aspects of tax, due to the first payment in particular which does cause so many issues to many individuals.  Please contact us on 0161 952 4244 for any assistance.