HMRC’s payment on account scheme is straightforward if you remember to plan for it; if you don’t it can catch you and thousands of other small business owners off guard each year.
If you’ve recently started your own business or working in a self-employed capacity, this twice-yearly tax payment system might come as an unwelcome surprise as HMRC will often ask you to pay not only your current tax bill but also money towards next year’s liability.
There’s plenty of potential for confusion, however once you understand how the system works, you can plan your cash flow properly and avoid any nasty surprises.
In this guide, I’ll explain exactly what payment on account means for you as a small business owner, when you need to pay, and how to manage these payments effectively. Whether you’re just starting out or need a refresher on the rules, this article will help you navigate the British tax system with confidence.
What is payment on account and who needs to pay it
Payment on account is a tax system designed by HMRC that requires certain taxpayers to make advance payments towards their future tax bill. Rather than paying your tax in one lump sum after filing, these payments spread your tax liability across the year.
The system works through two equal instalments, each representing half of your previous year’s tax bill. These payments are due by midnight on 31 January and 31 July. For example, if your tax bill for one year was £3,000, you’d need to make two payments on account of £1,500 each for the following tax year.
Payment on account for self-employed and small business owners
Payment on account primarily affects self-employed individuals and small business owners who pay their taxes through Self Assessment. This system exists to help both taxpayers and HMRC – for business owners, it prevents the shock of a massive tax bill all at once, while providing HMRC with a steadier revenue flow throughout the year.
Here’s where things can get tricky for first-time self-employed taxpayers. In your first year of self-employment, you effectively pay 150% of your tax bill in one go. This happens because you’re paying:
- Your current year’s tax bill in full
- Your first payment on account towards next year’s bill
For instance, imagine you’re a tailor with an Income Tax and Class 4 National Insurance liability of £1,200 for your first year. On 31 January, you’d need to pay £1,800 (£1,200 + £600) to HMRC, followed by another £600 on 31 July.
It’s worth noting that payment on account covers Income Tax and Class 4 National Insurance contributions, yet does not include student loan repayments or Capital Gains Tax.
When are you exempt from making payments?
Despite what many think, payment on account isn’t mandatory for everyone. You’re exempt from making these payments in either of these circumstances:
- Your Self Assessment tax bill for the previous year was less than £1,000
- You’ve already paid more than 80% of your tax through deductions at source, such as through PAYE
To illustrate this exemption: if your tax liability for the previous tax year is under £1,000, you’ll simply make a single payment by 31 January rather than having to make payments on account.
Additionally, even if your tax bill exceeds £1,000, you won’t need to make payments on account if 80% or more of your tax was already deducted at source through PAYE or other deductions (such as tax deducted from savings interest by your bank).
Once you’re in the payment on account system, you’re automatically enrolled after submitting your Self Assessment tax return – there’s no separate registration process. Nevertheless, if your income fluctuates significantly year to year, this system can sometimes feel unfair as it predicts you’ll earn the same amount in consecutive years.
Understanding this system is crucial for managing your business finances effectively, particularly since unexpected tax payments can significantly impact your cash flow.
How is payment on account calculated?
The calculation of payment on account follows a straightforward formula based on your previous tax bill. Understanding exactly how HMRC works out these figures can help you budget effectively and avoid cash flow problems throughout the tax year.
It’s down to your previous year’s tax bill
HMRC calculates your payments on account based on your total tax liability from the previous year. The process is quite simple—each payment equals 50% of your last tax bill. In other words, HMRC assumes you’ll earn roughly the same amount in the current tax year as you did in the previous one.
Let’s look at a practical example. If your 2023-24 tax bill totalled £4,000, your payments on account for 2024-25 would be two payments of £2,000 each—one due by 31 January 2025 and the other by 31 July 2025.
It’s important to note that these payments only cover Income Tax and Class 4 National Insurance contributions. They do not include:
- Capital Gains Tax
- Student loan repayments
- Other taxes you might owe
What are balancing payments?
Naturally, your income may not be exactly the same each year—especially as a small business owner. Consequently, your advance payments might not perfectly match your actual tax liability once you complete your Self Assessment for the current year.
When this happens, you’ll need to make a balancing payment. This is simply the difference between your actual tax bill and the payments on account you’ve already made.
For example:
Your tax bill for 2023-24 is £3,000. Based on your previous year’s earnings, you made two payments of £900 each (£1,800 total) on 31 January 2024 and 31 July 2024. As your payments didn’t cover the full amount, you need to make a balancing payment of £1,200 (£3,000 minus £1,800) by 31 January 2025.
Additionally, on that same date (31 January 2025), you’ll also need to make your first payment on account for the 2024-25 tax year, which would be £1,500 (half of your 2023-24 bill). This means your total payment on 31 January 2025 would be £2,700 (£1,200 + £1,500).
Conversely, if your actual tax bill is lower than anticipated, HMRC will refund you or adjust your next payment accordingly.
How does this work with National Insurance?
National Insurance contributions form a significant part of your payment on account calculations—specifically Class 4 NICs, which self-employed people pay on their profits.
When HMRC calculates your payments on account, they include both Income Tax and Class 4 National Insurance contributions. This means your twice-yearly payments cover both obligations, rather than handling them separately.
According to official guidance, “”References to payment of income tax apply equally to payments of Class 4 NICs””. Therefore, in practise, each payment on account includes a portion for your Class 4 NICs liability for the year.
To illustrate with figures: If your Income Tax was £6,405 and your Class 4 NICs were £650 for the previous tax year, your payments on account would each be 50% of the combined total. So you’d pay £3,202.50 (for Income Tax) plus £325 (for NICs) at each payment date.
This integrated approach simplifies your tax affairs by bundling these liabilities together, although it does mean your advance payments are larger. Notably, Class 2 NICs (the flat-rate National Insurance that self-employed people pay) may also be collected alongside your Self Assessment tax, forming part of your total bill.
How to make your payments
Meeting your payment on account deadlines requires planning and organisation. Once you understand when and how to pay, you can manage your tax responsibilities much more effectively and avoid unnecessary penalties.
Remember deadlines: 31 january and 31 july
The tax calendar for payment on account revolves around two critical dates:
31 January – On this date, you must pay:
- Any remaining tax from the previous tax year (your balancing payment)
- Your first payment on account for the current tax year
31 July – This mid-year deadline requires:
- Your second payment on account for the current tax year
For context, if you’re submitting your Self Assessment for the tax year ending 5 April 2025, the filing deadline and first payment deadline would be 31 January 2026, with the second payment due on 31 July 2026.
Be mindful that the 31 January deadline effectively means you might need to pay 150% of your annual tax bill at once—100% of the previous year’s liability plus 50% advance payment for the current year.
Payment methods: online, bank transfer, cheque
HMRC offers several ways to make your payments:
Same or next day processing:
- Online banking using Faster Payments
- CHAPS (Clearing House Automated Payment System)
- Debit card payments online
- Bank payments (with an HMRC paying-in slip)
Three working day processing:
- Bacs payments
- Cheques sent by post
To pay by bank transfer, you’ll need HMRC’s bank details and your 11-character payment reference (your 10-digit Unique Taxpayer Reference followed by the letter ‘K’).
For postal payments, send your cheque to “”HMRC Direct, BX5 5BD”” made payable to ‘HM Revenue and Customs only’. Write your payment reference on the back of the cheque to ensure it’s correctly allocated to your account.
Corporate credit cards are accepted but incur a fee, whilst personal credit cards are not accepted at all.
Setting up a budget payment plan
Instead of waiting for the payment deadlines and facing large bills, you can spread your tax payments throughout the year with a budget payment plan:
This voluntary arrangement allows you to make regular weekly or monthly payments by Direct Debit towards your next tax bill. To set this up:
- Log into your HMRC online account
- Select ‘Direct Debit’ and choose the ‘Budget Payment Plan’ option
- Decide on your payment frequency (weekly or monthly) and amount
The key benefit is improved cash flow management—your payments accumulate and are applied to your next tax bill, reducing the amount due at the deadline. If your payments don’t cover the entire bill, you’ll need to pay the difference by the usual deadline.
To qualify for a budget payment plan, you must be up to date with your previous Self Assessment payments [17]. You can pause payments for up to six months if needed, providing valuable flexibility for small business owners facing temporary financial challenges.
How to reduce or adjust your payments
Business circumstances change frequently, which is why HMRC allows adjustments to payment on account amounts when your financial situation shifts. This flexibility helps small business owners manage cash flow more effectively during unpredictable trading periods.
When you can request a reduction
You can apply to reduce your payment on account if you have good reason to believe your tax bill will be lower than the previous year. Valid reasons include:
- Your business profits have decreased
- Your tax relief entitlements have increased
- More tax has been deducted at source than in the previous year
This adjustment isn’t automatic—you must actively request it from HMRC. Otherwise, the tax authority will continue to expect payments based on your previous year’s liability.
How to apply online or by post
There are two straightforward ways to request a reduction:
- Online application:
- Log into your HMRC online account
- Navigate to the Self Assessment section
- Select “”Amend Self Assessment Return”” or “”Reduce payments on account””
- Enter your reduced payment amount
- Provide a clear reason for your reduction request
- Postal application:
- Complete form SA303
- Print and post it to your HMRC office
Importantly, you must submit your request by 31 January following the end of the tax year in question. For example, to reduce payments for the 2023-24 tax year, apply by 31 January 2025.
When applying, you must include a specific reason for your request. HMRC’s internal manuals clearly state that a request without justification is not considered valid.
The risks of underestimating your tax
While reducing your payments might help short-term cash flow, there are significant risks to consider:
Should you underestimate your tax liability, HMRC will charge interest on the difference between what you paid and what you should have paid. This applies even if you made an honest mistake in your calculations.
Additionally, making an unjustified reduction request primarily to avoid paying tax could potentially lead to penalties beyond just interest charges.
Before requesting a reduction, consider calculating the impact on your tax liability carefully. For example, if you expect your income to decrease by £5,000 and you pay tax at 40%, your tax liability would reduce by approximately £2,000.
What happens if you overpay or miss a deadline?
Dealing with tax payment errors can be stressful for small business owners. Fortunately, HMRC has established processes for both overpayment refunds and missed deadlines.
How are refunds processed?
When you overpay your payment on account, HMRC will either refund the excess amount or apply it to your next tax bill. Upon identifying an overpayment, you have two main options: request a direct refund or create a credit for future tax liabilities. Many business owners choose to leave overpayments as credit, effectively creating a financial cushion for upcoming tax obligations.
For direct refunds, HMRC typically issues payment through the same method you used to pay your tax. The processing time varies, generally taking between 3-5 weeks for most refund requests. To claim a refund, you must do so within specified time limits—typically within three years from the end of the tax year in question.
Interest and penalties for late payments
Missing your payment on account deadline triggers immediate consequences. HMRC charges interest on late payments starting from the day after the payment was due. Moreover, if your payment remains outstanding for 30 days, a penalty of 5% of the unpaid tax applies.
The penalty structure increases with time:
- 0.5% of the unpaid amount for each month or part month it remains unpaid
- Additional 5% penalty if still unpaid after 6 months
- Further 5% penalty if still unpaid after 12 months
Using HMRC’s time to pay service
Should you face difficulty meeting payment deadlines, HMRC’s Time to Pay service offers a lifeline. This arrangement allows you to spread tax payments over manageable instalments based on your financial circumstances.
To apply, contact HMRC as soon as you recognise you’ll have trouble paying. The service is more readily available if you approach HMRC before the payment deadline rather than after. While using this service, you’ll still incur interest on outstanding amounts, yet you’ll avoid additional penalties as long as you maintain the agreed payment schedule.
Conclusion
Managing payment on account effectively stands as a crucial skill for any self-employed person or small business owner in the UK. Throughout this guide, we’ve explored how this tax system works and why HMRC requires advance payments towards your future tax bills.
Understanding the payment deadlines—31 January and 31 July—helps you plan your finances accordingly and avoid the shock of unexpected tax demands. Most importantly, recognising that your first year of self-employment might require a larger payment (effectively 150% of your tax bill) allows you to prepare properly.
The calculation method, while straightforward, requires attention, particularly when your income fluctuates year to year. HMRC bases your payments on your previous year’s tax liability, making it vital to track your earnings and potential tax obligations throughout the year.
Though payment on account might initially seem challenging, several options exist to make it more manageable. Budget payment plans offer flexibility by spreading payments across the year, while the reduction request process provides relief when your income decreases significantly.
Additionally, knowing how HMRC handles overpayments and late payments helps you navigate these situations confidently should they arise. The Time to Pay service offers a valuable safety net during financial difficulties, though acting before deadlines pass remains the best approach.
Above all, staying organised with your tax affairs prevents stress and financial strain. Setting aside money regularly for tax payments, keeping accurate records, and understanding your obligations will make payment on account a routine part of your business operations rather than a twice-yearly headache.
Remember, payment on account simply spreads your tax liability across the year—it doesn’t increase what you owe overall. With proper planning, this system can actually help your cash flow management and make tax time less daunting.
FAQs
Q1. What is payment on account and who needs to make these payments?
Payment on account is a system where certain taxpayers make advance payments towards their future tax bill. It primarily affects self-employed individuals and small business owners who pay taxes through Self Assessment, with payments due by 31 January and 31 July each year.
Q2. How is payment on account calculated?
Payment on account is calculated based on your previous year’s tax bill. Each payment is 50% of your last tax bill, covering Income Tax and Class 4 National Insurance contributions. For example, if your previous tax bill was £4,000, you’d make two payments of £2,000 each.
Q3. Can I reduce my payments on account?
Yes, you can request to reduce your payments on account if you have good reason to believe your tax bill will be lower than the previous year. You can apply online through your HMRC account or by post using form SA303, but be cautious as underestimating may result in interest charges.
Q4. What happens if I miss a payment deadline?
If you miss a payment deadline, HMRC will charge interest on late payments starting from the day after the payment was due. After 30 days, a penalty of 5% of the unpaid tax applies, with additional penalties for longer delays. It’s best to contact HMRC promptly if you’re struggling to pay.
Q5. Is there a way to spread my tax payments throughout the year?
Yes, HMRC offers a budget payment plan that allows you to make regular weekly or monthly payments by Direct Debit towards your next tax bill. This can help improve cash flow management by accumulating payments throughout the year, reducing the amount due at the deadline.
