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Payment on account

“Payment on account” is an aspect of the UK self assessment system which many self-employed taxpayers find simultaneously confusing and worrying. As you know, the self assessment deadline of January 31st has just passed but another deadline is approaching – “payment on account” day of 31st July.

For newly self-employed people, especially those in their first two years of trading, the payment on account system comes as a very unwelcome surprise. There is a very real danger that, if not planned for, it can hobble the cash flow of a new venture because of the size of the liability involved.

In this article, TWP Accounting explains what “payment on account” is and how it affects you.

Payment on account – a definition

The self-employed make two tax payments during the year, one on the 31st January and the other on the 31st July. This system of having to make two payments but only submit one self assessment form is called “payment on account”.

Payment on account – how much do you need to pay?

What you need to pay is based upon the calculations from your previous year’s self assessment.

We always find using an example helps so, in this case, say “hello” to Ken. Ken has been trading for four years and, at the end of his 2017/2018 tax year, he had accrued £50,000 worth of tax liabilities from the profits on his trade as a conservatory replacement roof installer. This is the second year in a row his tax liabilities have been £50,000.

Ken will pay £25,000 in tax on the 31st January 2019 and a further £25,000 on the 31st July 2010.

That seems very straightforward but what if that amount of tax he pays goes up?

Payment on account – the balancing payment

In 2018/2019, Ken did really well and, as a result, his tax bill went up from £50,000 to £70,000.

Because what Ken pays in based upon the previous year’s income on which he accumulated £50,000 in tax he had to pay HMRC, he will pay £25,000 in tax on the 31st January 2019 and a further £25,000 on the 31st July 2019.

The problem is that HMRC is down £20,000 in tax and, as we all know, HMRC aren’t likely to forget this. Ken must pay the additional £20,000 in tax on the 31st January 2020 – this £20,000 is Ken’s balancing payment.

The amount of tax Ken pays in 2020 will change from previous years. His payment on 31st January will be half of his 2018/2019 tax bill (£35,000) plus the £20,000 balancing payment. In total, on that day, he’ll transfer £55,000 to settle his account with the taxman. His payment on the 31st July will be half of his 2018/2019 tax bill totalling £35,000.

If Ken hadn’t seen that increase in his income and accumulate another £50,000 tax bill, his payments would have remained at £25,000 on both 31st January 2020 and 31st July 2020.

There are two variations on the payment on account system we need to tell you about:

  • if your tax bill is less than £1,000, you can pay it all off in one go. Please be aware though that if the amount you pay in tax rises above £1,000 over the course of a tax year, you will then be expected to pay in two instalments, and
  • if more than 80% of the tax you pay is paid at source, you don’t have to make two payments.

Payment on account – your first year

Because payment on account is based on your previous year’s tax, what happens in your first year? Let’s say that, in your first year (the 2018/2019 tax year), you owe HMRC £10,000 in tax, you will have to pay that in full to HMRC by the 31st January in the year following the end of the tax year (i.e. 31st January 2020).

However, they’re going to want you to find 50% of that £10,000 for payment on 31st July 2020 – that’s another £5,000 you pay to pay which will then be followed by another £5,000 on 31st January.

Between 31st January 2019 and the 31st January 2020, HMRC will expect you to pay £20,000 in tax – that’s a lot of money to come out of a new business. It’s no wonder so many new traders worry about it.

Help with payment on account

If you would like to talk with one of our team of qualified accountants how the payment on account system works for you, please call us today on 01932 704 700 or email your accounting partner at service@twpaccounting.co.uk.

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