Payments on account can often cause confusion due to both their calculation and the fact the payments straddle tax years.
Basically, payments on account are just in-advance tax payments that are set against one future year’s tax liability.
They are calculated based on the figures for the previous tax year, so unless the tax position is exactly the same the payments may either be lower or higher than the actual liability.
If they turn out to be too low, they are not adjusted upwards when the actual figures are known – they remain at the level from the previous tax year with a balancing payment not due until the usual following 31st January payment deadline. Therefore, there is no penalty to completing the tax return as soon as possible.
If the tax liability for the year is expected to be lower, then the payments on account can however be reduced in line with estimates. Care must be taken not to lower them too much, otherwise interest and possible penalties can be charged. Therefore, completing the return as soon as possible also brings benefits in this case.
An example may make the situation easier: say there was a 2018 tax liability of £2,000 and this was eligible for 2019 payments on account to be charged.
The £2,000 liability for 2018 would have been due to HMRC by 31st January 2019.
Payments on account (pre-payment towards the 2019 tax liability) would be £1,000 each; and would be payable to HMRC by 31st January 2019 and 31st July 2019.
Although the January payment on account is before the 2019 year has ended, the July payment occurs afterwards. It is therefore important to complete the 2019 tax return before 31st July to see if the payment(s) can be reduced. It is also useful to know in advance what payments are required to HMRC in both 2019 and 2020 from the completed return.
Because three different tax years are referred to, confusion can often arise. You are making payments in both the 2019 and 2020 tax years, based on information from the 2018 tax year.
The amount due to HMRC can also be a source of confusion, particularly for new businesses who have not made payments on account before.
A common error when people complete their own estimates is not including national insurance in their figures, so the first year’s payment can be higher than they were expecting. The payments on account will be 50% each of the higher amount, so the first tax payment due can amount to more than 150% of the rough figure they may have calculated and perhaps set aside.
If someone leaves completing their tax return until close to the payment deadline, they can get a nasty surprise and only have days to raise the funds to pay HMRC. (HMRC stopped accepting personal credit cards for tax payments some time ago.)