Financial Matters

With David Frederick FCCA | Marcus Bishop Associates | marcus-bishop.com

Payment On Account. Who? What? Why?

We are now into our 28th year of self-assessment, yet there is still ambiguity, confusion and misunderstanding of one of its central features, “payment on account”. Seasoned self-employed taxpayers and newly self-employed taxpayers alike are equally confused and misunderstand the operation of payment on account within the UK self-assessment system.

Payment on account is the advance payment that some self-employed taxpayers are required to make towards their next year’s income tax liability. Within the self-assessment system there is not one but two payments on account required from self-employed taxpayers. The first payment on account is 31st January and the second payment on account deadline is 31st July.

Whilst there is much debate on the burden of the existence of the payment on account, HMRC would contend this is to avoid the self employed being favoured over employees who pay their income tax periodically via the PAYE (Pay As You Earn) system. Moreover, unlike employees, self-employed taxpayers have the opportunity to pay their income tax liability by 31st January after the fiscal year ended the previous 5th April. This is some 5 days short of 10 months after the end of the fiscal year. Some PAYE taxpayers may regard his as an unfair advantage afforded to the self-employed.

However, the challenge for self-employed taxpayers, especially those new into selfassessment is how does this payment on account arise? There are two conditions that dictate whether a self-employed taxpayer will be liable to payment on account for the next fiscal year.

Firstly, for the year ended 5th April, was the self-employed taxpayer’s income tax liability greater than £1,000? Secondly, was less than 80% of their income tax liability collected via PAYE.

Whilst these two conditions may help some self-employed taxpayers fall outside of the net of payment on account, the majority of the self- employed taxpaying community will fall within. To incur an income tax liability under £1,000 requires a self-employed taxable profit of less than £5,000 per fiscal year. In addition, there is not a material number of the self-employed taxpaying community who are likely to have 80% or more of their income tax collected via PAYE. This second condition may only apply to PAYE employees with a secondary income stream from a self- employment activity.

When payment on account is required, it will include Class 4 national insurance contributions, but it will exclude student loan repayments. This begs the question; how much are these payments on account that the self employed are expected to pay? In short, the payment on account by 31st January and 31st July is equal to 50% of their income liability of the previous fiscal year ended 5th April. This is often a surprise to the newly self-employed taxpayer as they are either not conversant with the self-assessment system or had not obtained any professional advice or guidance before stepping into self-employment.

An example of how the payment on account system operates is set out below:

• Maurice a self-employed business coach, had a £4,000 income tax liability in his first year of trading as at 5th April 2023.

• His payment on account for 31st January 2024 and 31st July 2024, is respectively, £2,000.

• It should be recognised that Maurice’s income tax liability due on or before 31st January 2024 is a total of £6,000 and £2,000 on or before 31st July 2024.

All is well that ends well, it is possible to apply to HMRC to reduce payments on account. An application can be made, if the taxpayer expects their taxable profit to be less than the previous year.

However, if they successfully, reduce their payments on account and their tax liability is greater than expected, they will be subject to an interest charge payable on the unpaid income tax liability. Application to reduce payments on account always requires due care and attention.