1 November 2019    |    Taxation

Payments on Account – what are they?

Payments on Account are the way in which HMRC get you to pay next year’s tax bill in advance.

As a result, the idea is very simple but, inevitably, there are added complications that leave everyone scratching their heads.

It is best to think about Payments on Account as being the same as your electricity direct debit: every year it is adjusted and any over or under payment accounted for by adjusting your next series of payments.

Payments on Account

Let’s start by explaining the basics with how and when these Payments on Account arise.

Anyone can be affected by Payments on Account as HMRC try to get tax in advance for:

  • Income from self employment
  • Reductions in allowances
  • Untaxed income, such as dividends
  • Foreign income tax adjustments

It is easiest to imagine if we consider a simple example of Mr A who works full time via PAYE, but at the weekends is self employed as a personal fitness instructor. He prepares accounts to 5/4 each year, and after all expenses he has a tax liability of £2,000 in year 1, £3,500 in year 2 and £3,000 in year 3. He stops after year 3 due to injury.

When to pay Payments on Account?

The payments are normally due in each January and July in each 50% installments. If the total tax liability is less than £1,000 it is all due the following January, and no Payments on Account are due. This is the lower (de minimus) limit.

The next rule is that the Payment on Account is 50% of the previous years liability, with any further balance due the following January.

As Mr A has a £2,000 liability in year 1 his payments on account for year 2 will be £1,000 each and as the total tax liability is £3,500 for year 2, the balance of £1,500 is due the following January.

In year 3 the Payments on Account are £1,750 each, but this results in an overpayment of £500 for year 3.

This is best demonstrated in a simple table:

As you can see, the first payment due is the whole of the tax for year 1 plus 50% for year 2. Because of this, there is an 18-month tax bill in one go, which surprises most tax payers.  As the tax is unhelpfully due in January, this can cause cash flow issues.

Adjusting the Payments on Account

The simplest adjustment is to simply consider the position in year 3. The table assumes that the tax return is submitted after the July payment is due.

But, if Mr A knows that his profit has dropped then he might submit his tax return early. The effect of this will be to reduce his July payment, instead of him getting a refund later.

Tax tip: submitting your tax return early had lots of advantages, and no disadvantages.

The Payments on Account can never be increased, so you cannot be worse off.

The revised table of payments from above is now:

If only it were that simple...

What actually happens in the revised example shown above is that the January and July payments are changed to 50% of the amended value.  Because of this, the real table of patents due is altered to this:

The penalties arise

Because the payment of year 3 should have been £1,500 and he only paid £1,250 the underpayment of £250 is subject to a Late Payment Surcharge of 5%, because the correct tax wasn’t paid by 28/2. A further consequence is that a 5% surcharge arises if it wasn’t paid by 31/7. Moreover, interest also runs from 31/1 until the date of payment on the late £250.

Tax tip: do not reduce your Payments on Account by too much to avoid these penalties.

For more information contact Liam McCreath, Tax Manager, to avoid this problem. And, yes, just file your Tax Return early is the best answer to avoiding that headache.

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