Payments on account – explained!
28 September 2020
As we approach the tax return deadline, I thought now would be a good time to post a blog about Payments on account due for Self-Assessment Income Tax.
Payments on account is common area of confusion and although designed to help taxpayers can often lead to increased financial hardship and confusion especially to new taxpayers on self-assessment.
What are payments on account and why are they necessary?
Before we look at what payments on accounts are, let’s look at how the tax payments work first. When the tax year finishes on the 6th April you will have just under 10 months to file your tax return and pay your tax liability, which is due on the 31st January. You can see there is already a time lag between the period you are accounting for and when the payment of tax is due.
HMRC assumes you will continue to make the same level of profits the following tax year and will have the same tax bill. HMRC therefore asks for 2 payments on account based on last year’s tax bill to be paid in 2 equal instalments in January and July. You should think of these payments on accounts as deposits towards next year’s bill as these are not your actual tax bill. They will be deducted off your next year’s tax bill. If you have overpaid then you will be refunded the difference, if you have not paid enough then you will pay the balancing payment next year.
Example- sometimes things are easier to explain with examples. So, let’s look at an example:
Bob is a builder, in the tax year ended 5th April 2020 he made £40,000 profit and has a tax bill of £10,000. His tax bill will be payable on the 31st January 2021.
HMRC will then assume he will continue to make £40,000 profit in the following year so by the time his tax is payable he would have had another 10 months of earnings, so HMRC will ask him to pay another £5,000 towards his next year’s tax bill. He will then be asked to make another payment on account by the end of July 2021.
Now let’s fast forward 12 months. Bob now completes his tax return for the tax year ended 5th April 2021, he made the same profit and has the same tax bill of £10,000. He has already made 2 payments against this of £10,000 meaning he has no balancing payment to pay but will have to make his next payment on account towards the next year of £5,000.
In practice his tax bill will either be higher or lower than the previous year and so he will either have a small balance to pay or a refund depending on how he does next year.
In summary, payments on account should be seen as a deposit payment towards next year’s tax bill.
It’s meant to help you spread your payments out during the year and at the same time provide the Exchequer with a financial boost in the middle of the year.
Reducing your payment on account
It would not be fair for HMRC to ask you to make payments on account based on last year’s profits if you are expecting smaller profits this year or maybe even no profits.
If you believe you will have a lower tax bill next year, then you can ask HMRC to reduce your payments on account and will have to give a reason why. You can do this through your tax return or make a claim online.
If you do reduce your payments on account but do not have a lower tax bill next year, then HMRC will charge you interest on the late payment of the original amounts due. If HMRC also believe you reduced the payments on account with no real basis for doing so, then you can be fined a penalty of the amount you reduced the payment by.
We hope you have found this blog useful. If you have any queries regarding payments on account or would like a free quote then please contact us – We offer complete accounting and finance services for small and medium size businesses, if you would like us to assist you, please feel free to get in touch with us for a free accounting and finance consultation. We are always happy to help you and your business!