What is a tax payment on account and do I have to pay it?

Question.

Every year I provide my accountant with all my personal financial information to allow him to prepare my business accounts and to file my tax return. Each year he advises me of my tax liability and the amount I need to pay on account. Can you explain how the tax payment system works?

Answer.

If you are self-employed or have income that is not taxed before you receive it, such as rental income, you may have a tax bill to pay. The tax year runs from 6th April to the following 5th April and any tax to be paid is due by 31st January following the relevant tax year. For example, for the tax year 6th April 2016 to 5th April 2017 (i.e. 2016/17) any tax to be paid would be due by 31st January 2018.

‘Payments on account’ are advance payments towards the tax bill you will owe for the next tax year. You need to make a payment on account if your tax bill is more than £1,000, unless you have already had more than 80% of it collected at source. You might have paid this through your PAYE tax code or it might have been deducted from any additional income you have, e.g. the interest on your savings. If the payments on account you’ve made are higher than your tax bill, HM Revenue & Customs (HMRC) will refund the difference. If you are required to make payments on account, budgeting for your tax bill can be even more important.

Each payment on account is half of your previous year’s tax bill. These payments are due on 31st January and 31st July.

The system of payments on account is best suited for taxpayers who do not experience significant fluctuations in their taxable income, because they are based on your income from the previous year. However, if your business profits or taxable income is down, you can ask HMRC to reduce your payments on account if you think your tax bill is going to be lower than last year. Be careful not to reduce them too far though – HMRC can charge you interest and penalties if you end up paying too little.

If you still have tax to pay after you’ve made your payments on account, this is called a balancing payment. You must pay your balance by midnight on 31st January after the end of the tax year.

As a rough guide, I would generally recommend that you put aside a quarter of your profits for your tax bill. If you’re a higher rate taxpayer (your profits or income are more than £40,000), then it may be preferable to increase the amount you put aside to a third.

You should also remember that from 13th January 2018 HMRC will no longer accept payment by personal credit card. Debit cards and corporate credit cards continue to be accepted.

The advice in this column is specific to the facts surrounding the questions posed. Neither FPM nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.