Improving cashflow by reducing payments on accounts… should you do it?
The Covid-19 pandemic has led to squeezed incomes and reduced earnings for many self-employed individuals.
If you expect your tax liability for the 2020/21 tax year to be lower than your 2019/20 liability it may be beneficial to reduce your payments on account early rather than wait for a refund later in the year.
The deadline for filing your 2019/20 tax return falls on 31 January 2021. This is also the due date for the first payment on account for the 2020/21 tax year. As a result, now is the time to consider whether you can reduce your payments on account.
Do you need to make payments on account?
Where you are required to pay tax under self-assessment and your last self-assessment bill was at least £1,000 you will need to make payments on account (except for situations where at least 80% of what you owe has been deducted at source, for example, PAYE).
Payments on account are advance payments towards your future tax and Class 4 National Insurance bill.
Payments on account based on previous year’s liability
The basic assumption made when calculating payments on account is that your tax liability for the next tax year will be similar to the previous tax years liability.
As a result, each payment on account is 50% of the previous year’s tax and Class 4 National Insurance liability. Class 2 National Insurance contributions are not taken into account when working out payments on account.
When payments on account due?
Payments on account are due on 31 January in the tax year and 31 July after the end of the tax year. Consequently, payments on account for 2020/21 are due on 31 January 2021 and 31 July 2021.
When you submit your tax return on or before 31 January after the end of the tax year you will either be due a refund or you will be required to pay additional tax relating to the tax year just ended (2019/20).
It is also important to note that the deadline noted above is also the due date for the next tax years’ (2020/21) first payment on account.
Falling profits for 2020/21 tax year
Payments on account for 2020/21 are based on actual profits reported for 2019/20. Where a business has been adversely affected by the Covid-19 pandemic any payments on account made / due will not reflect this because they are based on pre-pandemic profits.
If you are expecting lower profits in the 2020/21 tax year there is little sense in making higher payments on account than are needed. You may wish to reduce your payments due for the upcoming tax year. Note – SEISS and other Government grants are taxable, do not forget about these when calculating your projected profits for 2020/21.
How to reduce your payments on account
There are various ways in which you can tell HMRC that you want to reduce your payment on account.
This can be done by signing into your online personal tax account via the Government Gateway and using the ‘reduce payments on account’ option or by completing form SA303 and sending it to HMRC.
You can also tell HMRC you want to reduce your payments on account in the other information box on the self-assessment tax return. You will need to specify what you want to pay and the reason for the reduction.
Warning! – Beware paying too little
Where cashflow is tight, it may be tempting to reduce payments on account significantly in order to reduce your outgoings in January and July.
However, if you reduce your payments below the actual amount that due for each instalment (i.e. 50% of the liability for that year), HMRC will charge you interest on the shortfall between what you should have paid and what you have paid. This 50% figure can only accurately be identified after the tax year so it is better to be prudent when assessing your projected profits for the year.
Time to pay arrangements
Remember, if you are struggling to pay tax due on 31 January 2021, you can set up a ‘Time to Pay’ agreement to pay your tax in instalments. As long as you do not owe more than £30,000, this can be done online.