How do HMRC Self-Assessment payments on account (POA) work? Furthermore, how do these come about as part of the Self-Assessment system?
When you are a director of your own company, you will complete your Self-Assessment Tax Return each year. Whilst completing this, it is important that errors are not made when this is filed.
Once complete, your tax return will need filing with HM Revenue & Customs (HMRC). After your return has been filed, you will know your tax liability and if you need to make any POA. Therefore, let’s look into how Self-Assessment payments on account work.
Most contractors who run their own company will let their contractor accountant handle the filing of their tax return. However, it is good for you to know yourself how Self-Assessment works. Besides payments on account possibly being a consideration, it is also important to ensure that errors are not made on your Self-Assessment tax return.
HMRC Self Assessment payments on account
When they apply
First of all, as a company director and shareholder, you will have untaxed income in the future which comes in the form of dividends. When an individual has untaxed income such as dividends, self-employment income, rental profits etc, they need to register for Self-Assessment.
Based on your total overall income, you will need to pay to HMRC POA, unless:
- Your last SA tax bill is less than £1,000; and
- You have already paid the tax that you owe on at least 80% of your income. For example, you have been taxed at source through your tax code on your salary. Alternatively, your bank has already deducted tax on your interest income.
When do you pay the POA
Under Self-Assessment, HMRC will base the future POA on the previous year’s tax bill. These come in two equal payments that add up to your previous year’s Self-Assessment tax bill.
As part of your income tax return you may need to pay Capital Gains Tax, if you have made any gains. If you are self-employed, you may also need to pay Class 4 National Insurance (NI). Importantly, the payments on account are calculated on the previous year’s Income Tax bill only. They do not include any amount that you owe for Capital Gains Tax or Class 4 NI.
Therefore, the amounts that are payable on account in the future are against the following year’s tax bill. The first payment is due on 31st January and the second is due by 31st July after the end of the current tax year.
How do Self Assessment payments on account work -an example
If your total tax liability for 2020/21 was £15,000, this was previously payable in full by 31 January 2022.
In turn, your payments on account for 2021/22 will be based on your 2020/21 liability. Therefore you will need to make advance payments of £7,500 each.
These are due by 31 January 2022 and by 31 July 2022.
You may be paying Self-Assessment payments on account as set out above and you are earning less in the current tax year than in the previous year. Therefore, you will need to consider if you should reduce your POA.
In order to make a reduction, you can ask HMRC to reduce your POA (please see below). If you do not request any reduction, HMRC will assume that you will have earned earn at the same rate in 2021/22 as you did in 2020/21.
When you are new to the contracting world, the above may come as somewhat of a shock. However, this is how the system operates. Therefore, it is important that you budget for paying tax on account of the following year, when you start out contracting.
How the POA system works in more detail
Once you have made your first POA, you will effectively be in credit with HMRC. Any `balancing payment’ is payable to HMRC by 31 January 2023. If it turns out that your liability is less than the £15,000 in the above example, HMRC will refund any overpayment.
In the above example, if your actual tax liability in 2021/22 is £18,000 you would need to pay the additional £3,000 to HMRC by 31 January 2023. If your actual liability is £13,500 HMRC will refund the £1,500 overpayment to you.
The above may seem a little confusing, but your accountant should be there to help and guide you around this.
Reducing your HMRC Self Assessment payments on account
How do I reduce my POA
As mentioned, under the Self-Assessment system, it is possible to reduce payments on account for the following tax year. You can apply for this via the HMRC website online.
What’s more, you should only do this if you are reasonably sure that your taxable income will decrease in the next tax year.
When can you do this
When you know what your POA will be for the following year, you might think about reducing these and it could be tempting to do this. If you reduce POA, you reduce your tax burden. Please think this through carefully first of all though. If you reduce your payments in the future and it turns out that they are too low, this would create an issue as you will have underpaid tax. HMRC will also charge interest if you pay your POA late.
If required, your accountant will be able to apply to reduce your POA. If you do not reduce your POA and your tax liability for the following year is lower than the current year, HMRC will issue a refund.
Checking what you owe with HMRC
Under Self Assessment, you can check what you owe to HMRC at any time by setting up an online account with them. When you log into your account, this will show your current liability. It will also show any payments on account that are payable. There is also other helpful information in your HMRC online account, such as tax codes and state payments.
Paying your Self-Assessment tax to HMRC
When you come to making payment of your Self-Assessment payments on account or your balancing liability or indeed any other tax underpayment, you can make the payment by:
- Making payment via your personal internet banking. When you do this, please refer to this HMRC guide It details which sort code and account number to use as well as the reference to quote with the payment.
- You can also view this list of methods of accepted payment methods that HMRC accept.
Depending on your monthly drawings/dividends from your company, you should be saving for any personal tax as you go along, in a personal savings account.
In tax, HMRC treats dividends as the top slice of your income in your tax calculation. Any dividends in your basic rate tax band will incur Basic Rate tax at 8.75%. Meanwhile, any dividends in the higher rates tax bracket (gross income above £50,270) will incur a higher rate tax of 33.75%. If you are lucky enough to earn over £150K per annum, the additional higher rates tax is 39.35% on dividends that are above this amount.
Link to Contractor Advice UK group on