Payments on account - why are HMRC asking for next years' tax now?

As more and more people look to be become self employed or take a greater proportion of income in the form of dividends, payments on account are becoming the norm fortax-468440__340.jpg many.  Here we outline what these are, when they're applied and what it means.

What are "payments on account"?

‘Payments on account’ are advance payments towards your tax bill (including Class 4 National Insurance if you’re self-employed).   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.

Once you have submitted your tax return, you will know your tax bill and what you owe. Payments on account come in here. They’re part of the self assessment process and therefore relevant to UK tax payers where less than 80% of your income has tax deducted at source (that means tax deducted from your income before you receive it, such as where an employer pays an employee under the PAYE system).  

The first installment is due by midnight on 31 January and it is calculated by looking at your previous year’s tax bill. The deadline for the second installment is midnight on 31 July. Whilst spreading your payments out over the course of the year, this also helps the Exchequer by ensuring they receive what is effectively a forward payment by the summer. 

Each of your installments will usually be 50% of your previous tax bill. So consider the following simple, hypothetical example. If you paid £10,000 total tax in the 2016/17 tax year you would have to make a first payment on account of £5,000 by 31 January 2018 and, another £5,000 by 31 July 2018. Simple right? Not so I’m afraid, read on because you may well need to factor in a “balancing payment” moving forward and that might impact on your payment plan.

What happens if the tax I've paid on account is more or less than the actual tax liability?

After you submit the next self assessment tax return, there may be some more tax to pay (a "balancing payment") or you may have overpaid. 

Using our example; on 31st July 2018 you pay the second payment on account - i.e. you’ve paid a total of £10,000 by 31 July based on your 2016/17 tax bill. However, when your 2017/18 tax return is completed, you find your total tax bill for the 2017/18 tax year comes in at £12,000 based on your 2018 tax return. 

That then means you have an outstanding balance of £2,000 (£12,000 owed minus the £10,000 paid by 31 July). This is called the balancing payment and it has to be settled by 31 January 2019. Your 2019 payment plan would work as follows.

Total tax to pay on 31 January 2019 of £55,000 consisting of:

  • £2,000 balancing payment for 2017/18

  • £6,000 first payment on account for 2018/19 (50% of your 2017/18 total tax bill which was £12,000)

Another installment on 31 July 2018 of £6,000 for 2018/19 (the next 50% of your 2017/18 tax bill).

HMRC can refund you if your payments on account are greater than your total tax bill.

When do I NOT need to make payments on account?

You won’t have to make two payments in the year if:

  • You’ve already paid 80% or more of the total tax amount you owe
  • Your self assessment based tax bill came in at £1,000 or less

What can I do to keep payments on account down?

In addition, if you have a good reason to believe your tax bill will be much lower for the coming year (e.g. you've lost a major contract) then you can request HMRC reduce the payments on account.  To do this, either;

Bear in mind that if you do this and your tax bill turns out to be significantly higher than you've said, HMRC can charge you interest on the tax owed.

If you know that your tax bill is lower, you can always submit your tax return early - although the deadline is 31st January, you can submit it any time after April 6th.  This will allow HMRC to adjust your second payment on account if necessary.