What are payments on account and how are they calculated?
Many self-assessment taxpayers will already be familiar with the phrase ‘payments on account’ (POAs). They exist to spread the tax burden over the space of a year by requiring qualifying taxpayers to make advance payments towards their tax bill.
If the balancing tax payment for the year is either; more than £1,000, or less than 80% of the tax collected at source (this is generally via PAYE), Self-Assessment taxpayers are required to make two equal payments towards their tax liability, payable on 31 January and 31 July following the tax year in question. By design, the payments on account regime enables the Exchequer to collect the tax due at a much earlier point from individuals who are in receipt of investment income, as the tax is generally not withheld at source.
Each POA is calculated at 50% of the previous year’s tax liability. Should the total tax due in the current tax year exceed the two POAs combined, the additional amount, known as the ‘balancing payment’, is payable by the normal Self-Assessment filing deadline. This is 31 January 2022 for the 2020/21 tax year.
It is worth noting that while capital gains disposals are also reported on the Self-Assessment tax return, the current POA regime is a mechanism to collect tax on income and not capital gains. Therefore, a capital gains tax liability does not influence the POA due on 31 January and 31 July. However, with recent additions to the legislation, such as the Residential CGT regime, which ensures that any CGT arising must be paid on account to HMRC within 30 days of completion, it is possible that a POA regime for disposals of other types of assets could be announced in a future Budget.
Reducing your payments on account
While the POA regime undoubtedly serve its purpose, it would have been impossible to predict the considerable change in circumstances that a global pandemic has brought to so many people’s finances. Due to the various national lockdowns that have persisted since March 2020, many taxpayers will find that their taxable income in 2020/21 is lower than their taxable income in 2019/20.
However, the 2020/21 POAs are based on the income tax liability for 2019/20. This means there is a chance that the 31 July 2021 payment as calculated on the 2019/20 tax return will result in an overpayment of tax.
What if you over-reduce your payments on account?
You can if you evidence a reduction in profits, reduce your POA, but be warned HMRC do penalise taxpayers who over-reduce their POA. HMRC will charge interest at the official interest rate (currently 2.6% per annum), on the amount underpaid if this is the case.
What should you do?
The good news is that by sending your 2020/21 tax return information to us as soon as possible, we can determine your tax liability for 2020/21 and make a claim to reduce the upcoming 31 July payment to match what you actually owe. You also mitigate the risk of making an underpayment or overpayment of tax and having to wait in line for HMRC to process your refund later in the year.
Mark is a self-employed plumber. For his first year of business (2018/19), he was required to pay £2,000 in taxes to HMRC by 31st January 2020. He also needed to make payments on account for 2019/20. These were due on 31st January 2020 and 31st July 2020, and each instalment amounted to £1,000 (half of Marks previous tax bill of £2,000).
This meant that on 31st January 2020, Mark was required to pay a total of £3,000.
In filing his tax return for 2019/20, Mark discovered that his tax for that year was £2,500. As he had already paid £2,000, the amount that remained due was £500. This was due on 31st January 2021, and is known as the balancing payment.
Mark, of course, has to make payments on account for the 2020/21 tax year. The first instalment was due on 31st January 2021 together with the balancing payment for 2019/20 and the second instalment is due on 31st July 2021, and each payment amounts to £1,250 (half of Marks previous tax bill of £2,500).
As a result of COVID-19, Marks income actually dropped in 2020/21 and is not looking so good in the current tax year. He decides to reduce his second payment on account from £1,250 to £250, so he will have £1,500 in total to offset against his final 2020/21 tax liability.
SRC-Time are one of the South East’s leading accountancy firms in advising businesses in all aspects of their accounting and tax affairs and we are able to assist in any issue raised above.
Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at email@example.com or speak with an account manager to get any process started.