Self assessment – Why do we pay on account?
Whether you are self employed or employed and receiving untaxed income, you would have had to, at some point, file a self assessment tax return, or atleast sign one that was prepared by your accountant. Within the UK, there are set deadlines for when you have to pay your taxes by to HM Revenue & Customs. The two main dates are 31st January and 31st July.
Let us take the first date, 31st January. If your calculated tax liability for the financial year ended 5th April 2015 was £5,000 and you had not made any payments on account during the year, you would have to pay the full liability, £5,000, to HM Revenue & Customs by 31st January 2016.
At this point, HM Revenue & Customs will base your next financial years tax liability to be similar to the previous one. So they are assuming you will have to pay £5,000 in 31st January 2017 for your financial year ending 5th April 2016.
Based on this forecast, HM Revenue & Customs now expect you to make a part payment for the future tax liability. They expect you to make a payment of half of this liability. So you pay £2,500 (half of £5,000) on 31st January 2016 for the future year, along with the total liability of £5,000 for the financial year ended 5th April 2015. Thus, making the first payment on account.
The second payment on account is due by 31st July 2016. Again, as HM Revenue & Customs forecasted that you will have a similar liability of £5,000 to pay by 31st January 2017, they expect the second payment on account to be made during the year by 31st July 2016.
This is beneficial for those that have generated a larger income during the current year than the previous year. As HM Revenue & Customs are only expecting you to make the minimum payment, during the year, that covers the forecasted tax liability.
However, once you have made both the first payment on account and the second payment on account by 31st January 2016 and 31st July 2016 respectively. If your tax liability for the financial year ended 5th April 2016 was higher than the tax liability in the previous financial year, you will have to make a balancing payment by 31st January 2017.
With this balancing payment, you will also make your first payment on account for the forecasted tax liability for the financial year ended 5th April 2017. For example, if your tax liability was £7,000 for 5th April 2016 then you will make a payment of £2,000 (the balancing payment) along with £3,500 (the first payment on account) by 31st January 2017.
If your tax liability for the financial year ended 5th April 2017 was lower than the tax liability in the financial year ended 5th April 2016, then you have a balancing repayment, this means that you have paid too much tax during the year and will be repaid the difference. However, the first payment on account is still expected by HM Revenue & Customs, only this time, the first payment on account will be reduced by the balancing repayment.
For example, if your tax liability was £4,000 for 5th April 2016 then you will be repaid £1,000 (the balancing repayment) and you will have to make a payment of £2,000 (the first payment on account), therefore the net payment of £1,000 by 31st January 2017.
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About Alom Rouf
Alom is an Incorporated Financial Accountant and a Qualified Practising Member of the Institute of Financial Accountants. He has been in the accountancy industry since 2002. Throughout the years, he has gained a vast amount of experience in evaluating sole trader and partnership clients to assess whether they would be better off incorporating.