Payments on Account?! Since the Coronavirus (COVID-19) outbreak and following the strict government lockdown, many businesses and Self-employed individuals have seen a massive decline in income and profits. It is therefore not surprising that many businesses, struggled financially to cover their overheads and tax bill payments. Even though many businesses were eligible for the government grants and loans, many taxpayers, especially who became Self-employed just in the last year, i.e. after 6 April 2019, were left completely helpless. It is therefore not surprising that a massive number of taxpayers who are required to file a Self-Assessment Tax Return before 31 January 2021, opted to defer the second payments on account for 2019-20 (originally due by 31 July 2020) until 31 January 2021.
This may seem like a good idea for businesses and self-employed individuals that would have struggled to make the payment by 31 July 2020, however, many taxpayers that normally spread their tax bill payments do not seem to realise the impact it will on the total bill due in January 2021, which not only will include the balancing amount due for 2019-20 but will also the include the first payment on account towards the next tax year, i.e. 2020-21. Confusing? In this blog, we will try to explain how payments on accounts work and give clear examples to better understand how it affects the overall tax bill. But first of all, we need to understand what is meant by payments on account.
Payments on Account
For many taxpayers, the concept of payments on account is very confusing. In simple terms, payments on accounts are advance payments towards the next year’s tax bill, split into two payments. For example, if a tax payer had a total tax liability of £2,000 for 2018-19, then he or she will be required to make £2,000 advance payments towards next year’s tax bill. Why? Well, HMRC expects you will receive similar income the next year and therefore collects the tax in advance. However, it is uncertain that a taxpayer will earn the same amount of income the following year and the exact tax bill can only be established once the accounts for next year’s are completed.
Who needs to make Payments on Account?
Every Self-employed individual in the UK who has a tax liability of over £1,000 for the year, is required to make payments on accounts. For example, if your tax liability for the year is £2,000, you will be required to make two payments on accounts, the first payment on account of £1,000 will be due in January and a second payment of £1,000 will be due by 31 July. HMRC normally would issue a reminder letter to the registered addresses so the taxpayers do not miss the deadline.
Payments on Account – Examples
The below examples show how the tax liability and previous tax payments affect the total tax bill for the year and the payments on account for the following tax year.
EXAMPLE 1) NO PAYMENTS ON ACCOUNT DUE
Mr Peter A.. became self-employed since the start of May 2019 and he has calculated his tax bill to be £768. – Here, Mr Peter A. is not required to make any payments on account and Mr A. would be required to make a single payment before the payment deadline of 31 January 2021.
EXAMPLE 2) PAYMENTS ON ACCOUNT DUE
Mrs Juliet H. also become self-employed, she started her business in April 2018 and her tax liability for the year amounts to £3,000. – In this case, Mrs Juliet H. has to not only pay £3,000 but is also required to make payments on account. The first payment on account of £1,500 will be due by January, therefore, she has to pay a total of £4,500 by 31 January 2020. Additionally, she will be required to pay £1,500 for her second payment on account.
Claim to reduce Payments on Account
Most taxpayers usually do not choose to claim to reduce payments on account, however, this option is available for businesses and self-employed individuals who expect reduced turnover (and net profit) for the next year. Also, it is possible to reduce payments on account to NIL if you expect the business net profit will be substantially less and the tax bill for the year is not likely to succeed more then £1,000.
Incorporate a Limited Company
Another option to reduce to payments on account is when you are considering incorporating a Limited Company. As the income & expenses for the year will be declared under the limited company, your personal tax liabilities will reduce (as you are paying the corporation tax). This means your personal income tax will reduce (possibly to nil if you have no other income) and you can claim to reduce the payments on account.
However, it is worth noting, HMRC warns against reducing payments on account as this could result in fines and interest charges, if for example, you claim to reduce the payments on account due to expected lower income, but if later on, the tax liability is found to be higher, HMRC could impose penalties and interest on the tax that should have been collected through the payments on account. However, in our practice experience, we have not found any client that was investigated and fined for claiming to reduce payments on account. Get in touch today and we can help with your Self-Assessment Tax Return and advice on reducing payments on account.