What Is A Payment On Account And Do I Have To Pay It?
Once you have started working for yourself as a sole trader, one of its primary benefits is that you are not obliged to pay tax as money enters your business. Unlike employees wherein their earnings will be automatically deducted from tax through the PAYE system.
Since you are working as a self-employed, then most likely, you will be paying your first tax bill on January 31st which is after the end of your first tax year. Take note that this will run until April 5th.
So, for instance, if you started as a sole trader in November 2019 then you will have to wait for the Self Assessment deadline for the 2019/20 tax year before you pay your tax. This means that the due date of your tax will be on January 31 2021.
Moreover, limited company directors must also submit an annual Self Assessment tax return where they will reveal the income they obtained from different sources such as the dividends from their own company.
Payment On Account
Well, this is good news for all self-employed individuals. However, the bad news is HMRC is implementing a system known as “payment on account”. This is intended for those who are paying most of their tax using the Self Assessment method. Although this won’t apply to you if more than 80% of your earnings are being taxed through PAYE. On the contrary, if your tax bill reaches more than £1,000 based on your Self Assessment, then you will be required to make a payment on account.
Simply put, aside from the 2019/20 tax bill that will be due on the midnight of January 31, 2021, you are also required to pay 50% of your total anticipated tax for the 2020/21 tax year on the same due date.
Moreover, the remaining 50% of the 2020/21 tax bill should be paid on July 31, 2021.
This is done by HMRC to guarantee that self-employed individuals are not profiting by being capable of paying a large amount of tax several months in arrears. As a result, a lot of newly self-employed individuals have to face a tax bill which is almost 50% higher than what they are anticipating.
Delaying Your Payment On Account Due To Coronavirus (COVID-19)
To support UK businesses that were affected by the COVID-19 pandemic, the government announced on March 20th that the second Self Assessment Payment on Account intended for the tax year 2019/20 which is supposed to be paid on July 31st will be delayed until January 31, 2021. There is no need to worry since there won’t be any interest or penalties that will be implemented. Deferral is automatic, so you don’t have to worry about applying for a deferment in payment.
But bear in mind that opting for a delay in payment could likely result in some financial implications. Most probably, you could be facing some cash flow challenges in the succeeding year.
If you want to avoid higher costs in the future, then you could choose to pay your payment on account normally every July 31st. This is what HMRC is recommending you to do. If you are unable to pay your outstanding tax due to financial difficulty, then you can try applying for a “Time to Pay” arrangement. This can provide you a pre-agreed, time-restricted deferral period to pay any tax you owe to HMRC.
Some people are not aware of payment on account most especially those who have never gone through the Self Assessment system. What should you do if you are expecting a large tax bill, for instance, £10,000, and you are having a hard time finding an extra £5,000 to pay for your first payment on account?
If you are unable to pay your entire tax bill by January 31st, then most likely you will be facing some interest charges on your remaining balance.
Adjusting The Payment
Take note that the extent of your payment on account will be dependent on your tax bill for the past tax year. First of all, HMRC is expecting that you will continue earning at the same rate. Hence, you will be paying approximately the same amount of tax in the coming year.
If you are working full time or you anticipate that most of your incomes will be taxed at source, then it is possible that you can decrease your payment on account. However, if you will decrease your payment, then most likely, you will end up underpaying your tax. If this happens, then HMRC can charge you with interest and perhaps some penalties on the amount involved. If you require some advice on what you should do then you can contact your accountant.
After you have gone through your initial difficulty, payments on account will easily spread your tax bill throughout the year, making it easier for you to budget.
Eventually, this is all about giving importance to filing your tax return as early as possible, most especially if you are self-employed and this is your first time to file your tax return. In this way, you can avoid any surprises in January.