Few things in the tax system generate more alarmed phone calls than a first Self Assessment demand. Someone budgets carefully for a £6,000 tax bill, logs in, and finds HMRC asking for £9,000 by 31 January. Nothing has gone wrong. They have met payments on account.
What they are
Payments on account are advance instalments towards next year's tax bill. HMRC assumes your income will be broadly similar next year, and asks you to pay it in two chunks rather than in arrears. There are two dates:
- 31 January, alongside any balancing payment for the year just ended;
- 31 July.
Each instalment is half of your previous year's tax liability.
The worked example that explains the shock
Say your first year of self-employment produces a tax liability of £6,000, due by 31 January.
- 31 January: £6,000 balancing payment for the year, plus a first payment on account of £3,000 for the next year = £9,000.
- 31 July: second payment on account of £3,000.
You have paid £12,000 in six months against a £6,000 liability, but £6,000 of that is credit against next year. The following January you pay only the difference between your actual liability and the £6,000 already paid. It is a cash-flow shock in year one, not a permanent extra cost, but the year-one shock is real and catches almost everybody.
When you do not have to make them
Payments on account are not required if either:
- your previous year's tax liability was less than £1,000; or
- more than 80% of your tax for that year was collected at source, typically through PAYE, or deducted by a bank or contractor.
That 80% test is why an employee with modest freelance income often escapes them, while someone whose income is mostly self-employed does not.
What is, and is not, included
Payments on account cover your income tax and Class 4 National Insurance. They do not include Capital Gains Tax, which is payable in full with the balancing payment, and residential property gains have their own much tighter 60-day reporting and payment deadline. Student loan repayments are also excluded and fall due with the balancing payment. A year with a large gain therefore lands very differently from a year with the same amount of trading profit.
Reducing them, carefully
If you know your income will be lower, because you have taken a salaried job, lost a major client, or wound the business down, you can apply to reduce your payments on account. It is a straightforward claim, made through your Self Assessment account or on form SA303.
The catch is real: if you reduce them too far, HMRC charges interest on the shortfall, backdated to the original due dates, and can charge a penalty where the reduction was made carelessly or deliberately. Reduce on evidence, not optimism. Where the position is uncertain, it is usually cheaper to pay in full and reclaim the overpayment than to underpay and fund interest.
Budget for it from day one
The practical fix is simple and almost nobody does it in year one: set aside tax as you earn it, at a percentage that reflects your marginal rate, and treat the January and July dates as fixed. A separate savings account works better than intention. In year one, plan for roughly 150% of your expected liability in that first January.
Payments on account are also why leaving your return to January is expensive in a second way: filing early tells you the July figure months in advance, at no cost, and creates the option of a reduction claim before the money is due. We prepare returns early by default and forecast both dates for clients through our Self Assessment service. If your first payments on account are coming, talk to us before January rather than after.