As we’ve made it through another January we thought we would take a look at Self-Assessment Payments on Account. This is a key area of tax planning with sometimes major implications for cash flow. We often find that clients transferring from another advisor have been prompted to do so after getting a nasty surprise on this area so we thought we would run through how it works.
If you have to submit a Self-Assessment tax return you will be subject to Payments on Account if;
- Your self assessment tax bill is more than £1,000, and
- Any tax deducted at source (i.e. before you received the monies) was 80% or more of the total tax liability
As the name suggests, these payments on account are upfront payments to HMRC in respect of the current year. Payments on account are automatically calculated as half of the prior years’ total liability and are payable on 31 January in the current tax year and the 31 July following it. The best way to demonstrate this is by an example;
Example
Toby had a total tax bill for the tax year ended 5 April 2020 of £6,000. None of this liability had been deducted at source. Therefore, without any adjustment HMRC would automatically set the payments on account for the year ended 5 April 2021 at £3,000 each and would be payable on 31 January 2021 and 31 July 2021. If Toby’s tax bill for 2021 was exactly the same as 2020 then by the time he submits his 2021 tax return in say October 2021, he has already paid the tax liability.
Where payments on account become a crucial point in tax planning is where fluctuations in income are known, and the first year someone is under the Self-Assessment system. We look at each of these further:
First year under self-assessment
Taking the above example of Toby, if we imagine that the year ended 5 April 2020 was his first tax return, then he would have paid no payments on account of it. What this means for Toby is that after he submits his tax return for 2020, on the 31 January 2021 he will have to pay the £6,000 tax liability for that year plus a £3,000 payment on account of the 2021 tax year, meaning a total of £9,000 payable to HMRC. On the 31 July 2021 he will then have to make the second payment on account of £3,000. This first year is usually the most painful for this very reason and why we make sure clients are aware of their liability as far in advance as possible so that they can plan for it.
Income jumps up in a following year
The same is true where there is a jump in income. Again, taking the above example of Toby, in respect of the year ended 5 April 2021 he is making two payments on account of £3,000 each. What if his tax bill for that 2021 year was actually £10,000? Well in that case come 31 January 2022 Toby would have to pay the £4,000 extra (being the £10,000 less two lots of £3,000 he has already paid) plus his payment on account of 2021/22 which without any adjustment would be £5,000 (half of the £10,000 liability). So in this example Toby would have to pay £9,000 on 31 January 2022, followed by the second payment on account payment of £5,000 on 31 July 2022.
Income falls in a following year
We noted above that Toby had a tax liability of £6,000 for the year ended 5 April 2020, and so his automatic payments on account of 2021 were £3,000 each. What if Toby’s tax bill for 2021 was actually £4,000? In that case if Toby had made the two payments of £3,000 each he would be due a refund of £2,000, and his payments on account of 2021/22 would be £2,000 each (being half of the £4,000). What this would mean would be come 31 January 2022 Toby would be due a £2,000 refund and have to make a £2,000 payment – therefore he is actually at net zero. Considerations here would be;
- If Toby’s accountant had worked with him earlier and knew his 2020/21 tax liability was going to be lower then Toby could have elected to lower his payments on account. If they were in a position to accurately calculate ahead of 31 January 2021 then they could have made an election to lower the payments on account from £3,000 each to £2,000 each. This would have been a major cash flow advantage for Toby.
- Even if they could not predict 2020/21 was going to be lower until it had ended, Toby’s accountant could have encouraged his return be completed as soon as possible after 5 April 2021 and certainly before 31 July 2021. Toby would have already made a payment on account of £3,000 on 31 January 2021, however if they completed and submitted the return before 31 July 2021 then rather than pay his second payment on account of £3,000 on that date, he would only have to pay the £1,000 (being the £4,000 total liability less the £3,000 already paid). Still a major cash flow advantage for Toby.
Care needs to be taken to not lower the payments on account too much as HMRC may charge penalties and/or interest on the shortfall.
As you can see above, there are major personal cash flow considerations to make when looking at payments on account. At Veritons we are in regular contact with our clients to ensure we can spot these considerations as early as possible and be proactive in our advice. If that sounds like something you would like from your accountant and tax advisors then please contact us so we can start working together on an efficient solution.