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16th March 2023

When you start a business, one fundamental change is the way you pay taxes.

Under the Pay As You Earn (PAYE) system, your employer deducts and pays the necessary taxes and social security contributions to HMRC on your behalf. As a sole trader (unless you work via the CIS system), you will be liable for all of your taxes and NI in the subsequent January following the end of the current tax year on 5th April.

Most people are aware of the big January deadline. Something not many people are prepared for, however, are Payments on Account.

If you meet specific criteria, in addition to the tax you owe, HMRC will ask for pre-payments of tax for the following tax year. These payments are calculated based on your previous year’s tax bill and are due in two instalments.

HMRC would like you to think of this exercise as paying off some of your tax in advance and stopping you from getting too much in arrears.

Who has to make Payments on Account?

You will be asked to make two payments on account every year unless:

  • Your Self Assessment tax liability was less than £1,000
  • You’ve already paid more than 80% of the total tax you owe

How do Payments on Account work?

Each pre-payment is 50% of your previous tax liability. The instalments are due in January and July, respectively.

For example, let’s say 2022/23 is your first year trading. In April 2023, we calculate that you owe £5,000 – due 31st January 2024.

In addition to this, you will also pay the following:

£2,500 (50% of £5,000): also 31st January 2024

£2,500 (the remaining 50% of £5,000): 31st July 2024

Total due 31st January 2024: £7,500 (£5,000+£2,500)

Total due 31st July 2024: £2,500

Let us say things have gone well in your second year, and we calculate your tax as £7,500.

By 31st January 2025, you will be paying £2,500 (£7,500 less the pre-payments of £2,500 x two you have already made).

You will still need to make payments on account, calculated on the original tax owing of £7,500.

In addition to this, you will also pay the following:

£3,750 (50% of £7,500): also 31st January 2025

£3,750 (the remaining 50% of £7,500): 31st July 2025

Total due 31st January 2025: £6,250 (£2,500+£3,250)

Total due 31st July 2025: £3,250

This process continues each year until you no longer meet the Payment on Account criteria. This is usually due to moving to a PAYE role or leaving the UK. Payments on account do not include anything you owe for capital gains or student loans (if you’re self-employed) – you’ll pay those in your ‘balancing payment’.

Adjusting your Payments on Account

As the payments on account are based on your previous tax bill, HMRC assumes you will have roughly the same amount of income and, as such, owe a similar amount of tax in the following year.

Payments on account do not include anything you owe for capital gains or student loans (if you’re self-employed) – you’ll pay those in your balancing payment each January.

Given the inherent fluctuation in working for yourself, this is not always the case. At this point, if you know your taxable profits will be less in the following year, the payments can be adjusted to a lower level to reflect your reduced income.

Adjusting the payments negligently can lead to HMRC reinstating them in full and charging interest and possibly penalties. Definitely check with one of our team before going ahead with this.

Let MyAccountant help 

We hope that the above has helped answer your questions about Payments on Account.

If you’d like us to help you with your tax return, don’t hesitate to contact our tax manager Robert Trappe. If you are a client of ours, we are likely to have half of the information required to complete your tax return already.

Please remember to follow us on LinkedIn, Twitter and Facebook for regular updates, guides and industry news.

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