Unlike the PAYE system, when you start working as a sole trader or have a new untaxed source of income (e.g. rental income, dividend income) you won’t pay tax as money comes in. Instead, your first tax bill is likely to fall on the 31st of January after the end of the tax year (this runs until the 5th April).
For example- if you become a sole trader in November 2023 you would pay your first tax bill on 31 January 2025. This is because your payment would be made on the self-assessment deadline for the 2023/24 tax year.
SO, WHAT IS A PAYMENT ON ACCOUNT?
Payments on account are advance payments towards your tax liability. HMRC use this system to ensure that any tax liability is paid roughly at the time the associated income is earned. Anyone whose last Self-Assessment tax bill was more than £1,000 and paid less than 80% of their tax at source (for example, through their tax code or if a bank has already deducted tax from savings) must make these payments on account.
Two payments on account are due by midnight of 31 January and 31 July, each of half your previous year’s tax bill. They include Class 4 National Insurance contributions if you are self-employed.
If you still owe tax after making the two advance payments, a ‘balancing payment’ must be made by 31 January in the next year. This balancing payment will also cover anything you owe for capital gains or student loan payments, which are not included when calculating payments on account.
For example, if your tax liability for 2021/22 was £3,000:
- HMRC would ask you to make two payments on account towards your 2022/23 tax liability.
- A first payment on account of £1,500 by 31 January 2023
- A second payment on account of £1,500 by 31 July 2023
- If your tax liability for 2022/23 is more than £3,000, you will need to make a balancing payment by 31 January 2024.
- If your tax liability for 2022/23 is less than £3,000, you will receive a refund, or the difference will be deducted from your next tax bill.
WHAT HAPPENS IF I’M LATE WITH MY PAYMENTS ON ACCOUNT?
If you’re new to the Self-Assessment system, it’s likely that you’ve never heard of payments on account and they may come as a nasty surprise. If you’ve been expecting a tax bill of £12,000 suddenly having to find an extra £6,000 just to make your first payment on account might not be feasible. If the payment isn’t made on time, you could face interest charges at HMRC’s current rate of 7.75%.
If this is a position you think you might find yourself in, we recommend getting in contact with HMRC as quickly as possible. You might be able to make a ‘Time-to-Pay’ arrangement if you meet the criteria.
CAN THE PAYMENT ON ACCOUNT BE REDUCED?
If you know your tax liability will be less than the previous year, for example if you’ve ceased trading or your profits or other income has fallen, you can apply to reduce your payments on account. However, we would never recommend making a claim to reduce unless there’s evidence to support it. HMRC will challenge the position, if it later becomes clear that the payment on account should have been due as originally calculated. They will charge late payment interest on the shortfall and may also charge penalties in some cases, if the claim to reduce has been fraudulent or negligent. HMRC might consider this in cases where a taxpayer has very obviously made a false reduction or has a pattern of behaviour of unjustified claims.
It is advantageous to submit your tax return as early as possible, as you will then have plenty of advance notice of the tax payments that will be due before the submission and payment deadline of 31 January 2024. If your tax return can be completed before the end of July, you may be able to reduce or eliminate the payment due by 31 July if your tax liability has decreased from the previous year. It is always good to avoid making unnecessary payments to HMRC!
If you require any advice or assistance with your Self-Assessment tax returns, please get in touch with Helen Furniss, a member of our Private Client Team, or your usual AAB advisor.