One of the main differences between employment and self-employment is that when you are employed HMRC collect the tax on a monthly basis through your employer’s payroll system. (Of course, the other difference, which means HMRC would desperately love everyone to be employed, is that they also take an additional 13.8% slice as ‘employer’s national insurance’!).
When you are self-employed, HMRC don’t receive the tax that is due until you submit a personal tax return though. For example, if we consider the accounting period 1 April 2015 – 31 March 2016, you don’t need to complete your tax return and pay HMRC any tax until 31 January 2017. Very few organisations offer credit for a period of 10-22 months!
Due to this significant delay between the time you earn your income and the time you pay your tax on that income, HMRC introduced “payments on account”. Payments on account are where HMRC request a contribution to the tax due in advance. These payments are calculated based on the tax that was due in the previous tax year (if this was over £1,000) and split into two instalments; one in January and one in July.
It is important to stay on top of your finances, even more so if your profit is going up each year as you will need to prepare for the inevitable increase in your tax bill. It’s best practice to put money aside each month (approximately 30% of your income) to ensure you have the cash available to pay in January and July.
It is worth noting that if your income is likely to reduce or cease in the following year then you can claim to reduce your payments on account. This is relatively straightforward to do, however, care needs to be taken as if you reduce your payments too low then HMRC will charge interest on the difference.
Providing you are putting money aside for these bi-annual payments on account, it’s actually a good thing that HMRC split these payments. From a personal perspective, it spreads the payment over a period of time which can help with cash flow. After all, no one wants to be presented with a large tax bill due for payment just after Christmas.
If you have any concerns or questions about payments on account or if you would like to find out more about our accountancy services please call 01872 300232 or email us at hello@hivebusiness.co.uk.
