This particular area has caused confusion for many taxpayers over the years; hopefully, the following explanation will help to simplify it a bit!
Under self assessment, tax liabilities are based on tax years, which run to 5 April. The tax liability on a tax year is due by the following 31 January:
Tax year: 5 April 2011
Tax due: 31 January 2012
If the tax bill is less than £1,000, it is due by 31 January, gets paid and that’s it, end of story.
However, in general terms, if it’s more than £1,000, then you need to make ‘payments on account’ (POA) towards the next year’s tax liability, based on the previous year’s liability. The payments are 50% due at the end of January (still within the tax year to which it relates) and 50% at the end of July. Using the dates above, the POA would be by 31 January 2012 and 31 July 2012.
Dave finishes his tax return for y/e 5.4.11 and has a tax liability of £1,500. His tax payments are:
2011 tax liability £1,500
2012 1st POA £ 750
Due 31 January 2012 £2,250
2012 2nd POA £ 750
Due 31 July 2012 £ 750
In respect of the 2012 tax year, if Dave’s liability increased to £2,000, he would have a balancing payment of £500 (due by 31 January 2013), as he’d already paid 2 x £750 = £1,500. In addition to this, he would of course have POA for the 2013 tax year of 2 x £1,000 (50% of £2,000), due at the end of January 2013 and July 2013.
Hopefully, you can see that once you get into a pattern of payments on account, they start calming down, so that you have the same kind of liability in January and July. However, when you first start making payments on account, they can be quite a shock to the system (and wallet)!
The final point I want to make is that if your business profits are reducing, you can elect to reduce your payments on account, although you have to be very careful about this. If profits are subsequently found to have not reduced by as much as you’d claimed, you will get charged interest on any underpayments.