Introduction
The United Kingdom’s Self Assessment tax system requires individuals to calculate and pay their tax liabilities independently. This includes the tax due for the current tax year and any payments on account for the following year. Understanding how balancing payments and payments on account work is crucial for individuals to avoid unexpected tax bills and penalties. This article will explain the concepts of balancing payments and payments on account, provide examples of when they are needed, and illustrate how they can impact your tax bill.
Payments on account
Payments on account are advance payments you make twice a year towards your Self Assessment tax bill. HMRC estimate how much tax you owe for the upcoming year based on your previous year’s tax bill. You pay this estimate over two instalment dates to spread your tax payments throughout the year.
Who has to make payments on account?
You have to make two payments on account every year unless:
Your last Self Assessment tax bill was less than £1,000
You paid more than 80% of the previous year’s tax you owed, for example, through your tax code or because your bank had already deducted interest on your savings.
Each payment is half your previous year’s tax bill. Payments are usually due by midnight on 31 January and 31 July.
If you still have tax to pay after you’ve made your payments on account, you must make a ‘balancing payment’ by midnight on 31 January next year.
Example 1
John has a tax bill for the 2022/23 tax year of £2,000. John has paid £1,700 in tax at source as part of his employment. John would not be required to make payments on account towards 2023/24 because although his tax bill is greater than £1,000, he has paid more than 80% of his tax at source (1,700/2,000 = 85%)
Example 2
John has a tax bill for the 2022/23 tax year of £900, and he’s paid no tax at source. John has not paid any tax at source, but because his tax bill is less than £1,000, John would not be required to make payments on account towards 2023/24.
Example 3
John has a tax bill for 2022/23 of £3,000, and he’s paid no tax at source. As John’s tax bill was greater than £1,000 and he paid less than 80% of the tax owed at source - John will be required to make payments on account.
The payment on account will be half the previous year’s tax bill and due on 31 January and 31 July. So John must make two payments of £1,500 (£3,000 tax bill divided by 2).
What happens if I don’t make a payment?
HMRC will apply interest when settling your tax bill for any amounts that should have been paid earlier by a payment on account.
The interest HMRC apply is currently 7.75%.
Is there a way to avoid making payments on account?
Filing your taxes early in the tax year can be an effective way to avoid making the second payment on account in July - especially if your estimated tax bill will be lower than the payments on account that have been calculated.
You can also apply to reduce your payments on account if you estimate that your next year’s income will be considerably lower than the year you are filing for. To make such a claim, there must be a reliable indication that your estimated tax for the subsequent year will be significantly lower, and if this is the case, it would be reasonable to reduce your payments on account only to cover the estimated tax.
When Ember completes self-assessments, we will review, where appropriate, whether payments on account can be reduced. However, please note that if you reduce payments on account and end up with a tax bill greater than the payments on account paid, you will have to pay interest on any amounts that should have been paid via payments on account.
Balancing payment
A balancing payment is an individual’s final tax payment for a specific tax year. It occurs after the tax year ends, typically on 31 January following the end of the tax year (e.g., for the tax year ending on 5 April 2023, the balancing payment is due by 31 January 2024)
The balancing payment due will depend on whether you have made payments on account towards the tax year in question:
If you made payments on account towards the tax year you are submitting, the balancing payment due on 31 January will be the tax due for the year minus the payments on account you have made. If your tax bill is higher this year than last year, then you will have a balancing payment to make; however, if your tax bill for this year is lower than last year, you will be due a refund for the tax year as you would have overpaid.
If you have not made payments on account towards the tax year you are submitting - the balancing payment due on 31 January will be the tax due for the year.
Example 1 - overpayment of tax
John submitted a tax return for 2021/22 with a tax bill of £3,000. He paid no tax at source that year, so he was required to make two payments on account of £1,500 each towards the 2022/23 tax year. John made these payments on 31 January and 31 July per HMRC rules.
John is now submitting his 2022/23 tax return. His total tax bill for this year is £2,500, and John has paid no tax at source. John’s tax calculation would look as follows:
Tax due for 2022/23 = £2,500
Payment on accounts made (£3,000)
Balancing payment = £500 refund due for the 2022/23 tax year
John would be due to make two payments on account of £1,250 (£2,500/2) towards 2023/24.
So, in terms of cash outflows:
31 January 2024 - due a £500 refund from overpaying last year and £1,250 due in payment on account for 2023/24. This would net off to a payment of £750
31 July 2024 - £1,250 payment on account due for 2023/24
When John later submits his 2023/24 return, he will have made £2,500 in payments in advance towards this tax year.
Example 2 - underpayment of tax
Same scenario as Example 1, but for 2022/23, John’s tax due was £4,000 with no tax paid at source:
Tax due for 2022/23 = £4,000
Payment on accounts made (£3,000)
Balancing payment = £1,000 due for the 2022/23 tax year
John would be due to make two payments on account of £2,000 (£4,000/2) towards 2023/24.
So, in terms of cash outflows:
31 January 2024 - owes £1,000 from underpaying last year and £2,000 due in payment on account for 2023/24. This would mean a payment of £3,000 would be due.
31 July 2024 - £2,000 payment on account due for 2023/24
When John later submits his 2023/24 return, he will have made £2,500 in payments in advance towards this tax year.
Example 3 - no payments on account due the following year
Same scenario as Example 1, but for 2022/23, John’s tax due was £900 with no tax paid at source,
Tax due for 2022/23 = £900
Payment on accounts made (£3,000)
Balancing payment = £2,100 refund due for the tax year
John would not be required to make any payments on account as his tax bill is not greater than £1,000.
So, in terms of cash outflows:
31 January 2024 - John would receive a rebate of £2,100
No other payments are needed.
When John submits his 2023/24 return, he will not have made any payments on account towards this tax year.
Conclusion
Balancing payments and payments on account are integral components of the UK Self Assessment tax system for individuals. It’s crucial to understand these concepts, calculate your tax liability accurately, and make payments on time to avoid penalties and interest charges. By being aware of how these payments work and considering potential changes in income, individuals can better manage their tax obligations and financial planning.
Discussing these concepts with an accountant is always advisable, as the examples above are simplified to aid understanding of this complex topic. Accountants are also best placed to help advise regarding reducing payments on account and providing advice around managing the cash flow implications of payments in advance of tax.