New to business? Beware of payments on account!

When setting up in business you will be fully aware that you will have tax to pay on your profits, and you will ideally be putting money aside to cover this. What you might not be aware of is that you may have to pay two years’ worth of tax in just six months.

The first time your tax liability exceeds £1,000, assuming that 80% or more of your tax liability isn’t collected at source (i.e. deducted from a salary), you will be required to make payments on account for the following year’s tax liability.

Although the payments on account are deducted from your liability in the following year, meaning the overall tax you pay remains the same, payments on account can cause significant cash flow issues the first time you are due to pay them. The easiest way to demonstrate this is by way of an example:

Example                                                                              POA’s due                           POA’s not due

2016/17 Tax liability                                                       £1,100                                   £900

1^st POA for 17/18 (50% of 16/17 liability)                    £550                                      N/A

Total due 31^st January 2018                                          £1,650                                   £900

2^nd POA due 31^st July 2018                                            £550                                       N/A

As you will see, although there is only a £200 difference in tax liability in the above examples, the example in which payments on account are due will pay a total of £2,200 between 31^st January 2018 and 31^st July 2018 compared to just £900 for the example where they are not due – a difference of £1,300!

The above situation could also affect you if you operate through a limited company and take dividends from the company which push your tax liability over £1,000 for the first time.

Disclaimer - All information in this post was correct at time of writing.