With July tax payments having become due, many people are confused about what they should have paid.
Here is an example of payment dates for the self-employed or those with untaxed or insufficiently taxed income (with a chart version for those who prefer pictures to words).
Tax year 2015-16
Based on the year ended 5th April 2016, or if accounts are not prepared to that date, then for that source the accounting date ending in the year to 5th April 2016, the balance due for 2015-16 is payable by the 31st January 2017. At the same time a payment on account is required for the following year calculated as 50% of the total liability for 2016-17.
Then a second payment on account for 2016-17 of the same amount is due 31st July 2017 (the payment being made now). In January 2018 the full year’s tax for 2016-17 is due LESS the two payments on account already made.
So where income is steady, there will be little tax balance due as the payments on account will have covered it. Where income is rising, the January tax will be high, because payments on account will be too small to cover the full year’s tax.
The reverse would be true – that if income were falling, the two payments on account would be more than the overall liability, so a refund would be due. Where however it is known in advance that the tax liability will be less than the previous year, there is a mechanism to reduce the payments on account. Be cautious with this though, because if you reduce it too much there will be an interest charge back to the original due date.
Just to make it more complicated, not everything in the annual liability goes on to be included in the payments on account. These items are excluded:
- Class 2 NIC
- Capital gains tax.
- Student loan repayments
For young GPs, this can come as something of a shock, when there is still a large balance to pay on static income, caused by student loan repayments that are not included in the payments on account.
High income child benefit charge is however included in payments on account – so if you have stopped your child benefit (and you are the higher earner), or if you are the higher earner and your income has dropped below £50,000, then the payments on account might be too high.
And then there are instances when payments on account are not due at all – where more than 80% of your tax liability is deducted/paid at source. Usually this is where there is a PAYE employment as well as a self-employment. This can cause havoc with your budgeting where you are borderline with this, so one year you have enough tax paid at source not to make payments on account, and the following year you just tip the other way and need to make payments on account – so in that situation you have a January where you pay the whole of the previous year’s tax plus 50% more as a payment on account for the following year.
Throw into the mix maternity leave where income drops for a period and then increases again, or switching between salaried and self-employed and it becomes too complicated to guess at with any degree of accuracy.
Further confusion can arise where there is both salaried and freelance work, and an underpayment of less than £3000. In this case HMRC may ‘code out’ the underpayment – so they adjust it on the tax code operated against the salary – deducting more tax there instead of paying it separately and then this affects payments on account. They won’t do this if salaried income is very low proportionate to the outstanding tax, or if your tax return is submitted after the end December (before the 31st January filing date). Many people will prefer to pay the tax separately so they can see more clearly what is outstanding and what has been paid. There is a tick box on the self-assessment return for this choice.
Often if cash flow permits, people will make the first payment on account as requested and then deal with their tax return early in the tax year so that the correct amount is known before the July tax is due. Note that if income has increased, payments on account will not be increased as well – the balance is just paid the following January.
If you need a formal calculation of your position to see how much payments on account should be reduced by, make sure you give your accountant as accurate information as possible, and be prepared to pay for their time doing the calculations for you. Sometimes it is more cost effective to make an educated guess, and bear the interest charge if you guess too low – minimising interest by doing your return promptly after 5th April.
Note that you cannot recklessly reduce the payment on account without good reason – HMRC can charge penalties as well as interest if you don’t have some sensible grounds for the reduction.
Hopefully this will help some people who are confused about making payments on account. It does highlight the need to keep up to date with your tax affairs, so you have as much warning as possible about your tax liabilities.