As one of our most popular articles we have updated this for 2016.
Self Assessment is the bane of many self-employed people’s existence. The annual rush to get your tax return in on time, only to be presented with a whopping great bill, is one of the least entertaining parts of the year.
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 spread out their tax bill, it often results in increased financial hardship for those who are already having difficulty paying.
What is Payment on Account?
Payment on Account is a tax payment made twice a year by self-employed people in order to spread the cost of the year’s tax. It is calculated by looking at your previous year’s tax bill, and is due in two instalments.
The Payment on Account can be thought of as a way of paying off some of your tax bill in advance. The first instalment is due on January 31 (the same day as your ‘balancing payment’, which clears your tax bill for the previous tax year), and the second is due on July 31. It is intended to help you spread your payments out during the year – and, of course, to help provide the Exchequer with a financial boost in the middle of the year.
Each of the two instalments of the Payment on Account will normally be 50 per cent of your previous tax bill. So, if you paid £10,000 in the tax year for which you are filing your return, you will make the first Payment on Account of £5,000 on January 31, and another payment of £5,000 on July 31. This will include Class 4 National Insurance Contributions where applicable, but not student loan repayments or Capital Gains Tax.
There are some circumstances in which a Payment on Account will not be due. If your tax bill for the previous year was less than £1,000 after PAYE or other deductions at source, no Payment on Account is necessary. Similarly, no Payment on Account will be due if, in the previous tax year, 80 per cent or more of your tax was deducted at source.
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How to pay with Payment on Account
If you complete your Self Assessment online, you will be given the opportunity to make the Payment on Account at the same time as your balancing payment for the previous tax year. If you file your return on paper, you will receive a paper bill along with a Bank Giro form that you can use to make a payment.
HMRC is now committed to moving as much of the taxpaying process online as possible. As a result they are encouraging taxpayers to file and make payments online wherever possible. You can do this securely on the HMRC website, or by downloading their taxpaying software.
Reducing your Payment on Account
Self-employed peoples’ income can fluctuate from year to year. If you think that your income for the next tax year will be lower than in the previous tax year, you can apply to have your Payment on Account reduced.
If you calculate your own tax, you should find the Tax Calculation pages of your return and tick box 9 if you wish to reduce your Payment on Account. You can then write the amount you intend to pay in box 10, and explain the reason for doing so in box 16. If the taxman works out your bill for you, you will receive a copy of form SA303 with your bill. Fill this out to reduce your Payment on Account.
In practice, many people choose to do this if they are having trouble
paying their tax bill. Some individuals reduce their Payment on Account,
presuming that they will be in better financial shape later, and will
therefore find it easier to settle the remainder of their bill.
You should think carefully before doing this. Remember that, if your income is the same or higher in the next tax year, you will still have to pay the same amount.
All you are really doing is delaying the pain, rather than eliminating it altogether. It is also important to note that underpayments will be subject to interest. If you reduce your Payment on Account and it subsequently turns out that you have underpaid, you will have to pay interest on the outstanding amount. This can significantly increase your tax bill.
As with all tax matters, if you are confused you should contact your accountant or HMRC directly for advice. If you are having trouble paying, it is important that you act quickly. Call the HMRC Payment Helpline on 0845 366 1204 to enquire about setting up a new payment arrangement.