There's always a confusion around the July tax 'payment on account' for income tax under the self assessment regime.
If you are business owner, chances are you're under the self assessment regime and have to submit a tax return every year.
One of the advantages of being self-employed or a company director is that you do not have to pay income tax monthly under PAYE like normal employees. Given that you are in control of how you pay yourself - mainly via dividends - you can also control to some extent your tax payments.
How tax payments work
Your income is worked out for the tax year which runs from 6 April to 5 April the following year. You are then required to pay your tax liability in full by the 31 January following the end of the tax year.
This would mean that HMRC do not get your tax money until 9 months after the year in which you received the income. Clearly that would not be palatable for the Exchequer and therefore HMRC try and collect some of the tax due via estimated payments on account. These payments on account are required to be made on 31 January within the tax year and 31 July following the tax year end.
But how do I know how much tax to pay during the year when my tax return hasn't been prepared yet?Exactly. This is what makes payments on account so confusing to many! The payments on account are worked out at 50% of your previous year's liability and spread across the two payments in January and July. If you eventually owe more than this then you make a balancing payment on 31 January following the end of the tax year to cover it. If you owe less, you get a refund.
Let's take an example:
In 2016/17 Jack's tax liability due was £20,000 - keeping it simple. Let's assume that this was his first year as self employed/Director and therefore he paid the whole amount on 31 January 2018 once his tax return was submitted.
Jack's payment on account towards the next 2017/18 tax year - also due on 31 January 2018 - would be £10,000 (50% of £20,000). The same amount would be payable on 31 July 2018. Now, let's say Jack's actual tax liability for 2017/18 eventually turned out to be only £10,000 once his tax return was completed. He would therefore be due a refund for the overpayment of £10,000. The next payment on account for 2018/19 would be based on 50% of the 2017/18 actual liability and therefore be £5,000 due on 31 January 2019.
Still sound complicated??
The best thing you can do is get your tax return prepared and submitted before the 31 July following the end of the tax year. This means that your actual tax liability for the previous tax year is calculated and therefore if your income has fallen from one year to the next, you can reduce your 31 July payment on account accordingly - or even claim a refund from HMRC if the POA made in January covered your tax in full.
If you know your income may fall in the following year - for example you may have taken an exceptional dividend one year - ask your accountant to make a claim to reduce the payment on account - as otherwise it will always be based on 50% of the previous year's liability.
Good planning helps you keep more of what you earn!
Happy tax saving.