A Payment on account is the amount of Income Tax and class 4 National Insurance that some business owners have to pay to HMRC for a future tax year.....and it can be a little confusing.
Payment on Account is one of the most commonly misunderstood elements of the Self Assessment process. Although it was devised as a way of helping self-employed people ( that's sole traders and private limited company directors) spread out their tax bill, it often results in increased financial hardship for those who are already having difficulty paying.
Who has to make Payments on Account
If your Income Tax and class 4 National Insurance totals more than £1,000 for a tax year and you don't pay tax at source on more than 80% of your income, you'll have to make payments on account.
'Paying tax at source' is when the tax is taken off and paid over to HMRC before you receive the income - like your employer does if you are paid wages.
What are payments on account?
Payments on account are where the taxpayer pays 50% of the following years personal tax at the same time they settle their current year’s liability (in the case of the 16/17 tax year this payment will be due by 31 January 2018).
There is also a second payment on account due by 31 July for the remaining 50%.
Any payments on account made will be deducted from the tax owing the following year.
Example 1) Zoe is a self-employed seamstress. She has Income Tax and class 4 NI of £1,200 to pay for 2016/17, her first year of business. This is all due to be paid to HMRC by 31st January 2018.
Because her liability is over £1,000 and she does not pay tax at source, she must also make payments on account for 2017/18. These are due on 31st January 2018 and 31st July 2018, and are calculated as £1,200 / 2 ( £600) each.
That means that on 31st January 2018, Zoe must pay £1,200 + £600 = £1,800 to HMRC i.e £1,200 for her 16/17 debt and £600 as a payment on account for her 17/18 debt ( in effect a payment in advance). On 31st July 2018 Zoe must also pay HMRC £600 as her second payment on account for 17/18.
When Zoe actually does her tax return for 2017/18, let's say her liability for that year was actually £1,400. She'll already have paid £1,200 on account for that, so she has only £200 to pay to make up the difference. This is called the 'balancing payment' and will be due by 31st January 2019.
She will also have to make payments on account for 2018/19 of £1,400 / 2 = £700 each, on or before 31st January 2017 and 31st July 2017. So her Payment in Jan 19 will be £200 ( Balancing Payment) and £700 ( 1st Payment on account for 18/19) i.e. £900.
Example 2) Simon, a limited company contractor with no other income, extracting up to the maximum of the basic rate band by way of an optimum structure of £8,040 in salary and £34,960 in dividends would be taxed for the 2016/17 tax year as follows:
As you can see the total tax payable for the 2016/17 tax year, where the basic rate band is maximised, would be £2,025 and would be due to HMRC by 31 January 2018.
There would also be a payment on account due by the same date of another half of this amount (£1,012.50) with an equal amount due again on 31 July 2018 relating to the 2017/18 tax year.
Therefore, the total payments to HMRC due by the following dates would be:
31 January 2018 £3,037.50
31 July 2018 £1,012.50
(the above figures assume that you had not already made any payments on account for the 16/17 tax year when do you did your 15/16 tax return)
By paying the above amounts it would mean that £2,025 of the tax due for 2017/18 will have been paid by 31 July 2018 and as such on the filing of the 2017/18 tax return there would be a balancing payment (or repayment) on 31 January 2019 to tidy up the tax position for the year before payments on account were calculated for the 2018/19 tax year.
If therefore the actual Tax liability for 17/18 was £1,800 then the Jan 19 payment would be
a) a balancing payment would be a credit of £225 ( £2025 payments on account less £1800 actual tax bill) plus
b) a £900 payment on account for 18/19 based on 50% of the 17/18 bill.
Tax bill is lower than last financial year? Instances of over payment?
Payments on account can become potentially problematic if you earn a lot of income one year and this then drops significantly the next. You may foresee a cash shortage if you know for certain that your tax bill will be lower than last year. You can therefore request that HMRC reduce your payments on account.
Be warned though, reduce your payments on account by too much and HMRC will charge you interest and penalties for underpaying your tax (see next section). Alternatively, HMRC can refund you if your payments on account are greater than your total tax bill.
What payments on account doesn’t include
Payments on account exclude sums you may owe for capital gains or student loans. Instead, these items are covered in your balancing payment.
The need to put money aside for tax payments
You can access what you owe the tax man through HMRC online services. It provides you with the payments you need to make in January and July and also gives you access to historical payments on account.
This all highlights the need to be putting money aside regularly to ensure you’re able to fulfill your tax payments at the beginning and mid point of every calendar year. Find an advisor to help you put in place a tax payment plan that ensures you can manage your personal finances effectively.
How to Pay HMRC
You can pay HMRC via various methods.
Consider carefully that it takes 3 working days to process a payment via bacs, direct debit (if you’ve already set it up) and cheque (upon receipt). So you need to factor that in around the deadline. If you haven’t set up a direct debit arrangement with HMRC then remember that the first payment will take 5 working days.
If the payments on account deadline falls over a weekend or bank holiday, then you need to make sure your payment reaches HMRC on the last working day before.
Payments on account spread the cost of your tax bill into two installments over the year. It was designed as a method for paying some of your tax bill in advance and therefore to prevent people being indebted to HMRC.
It can be a little confusing though so if you are unsure please speak with your accountant.