If you’re self-employed, in a partnership, or a company director taking dividends, you’ve probably got a payment due to HMRC on 31 July. This isn’t your final tax bill for the year, that’s just finished. It’s a “Payment on Account” (POA), which is essentially 50% of your previous year’s tax bill, paid in advance.
For many business owners, especially during quieter summer months, this payment is painful. You might be tempted to reduce it, and sometimes that’s a legitimate option. But reducing your Payment on Account without proper justification is one of the fastest ways to create a tax bill and interest charges that will hurt far more than the short-term relief.
Here’s how to decide whether to reduce or not.
How Payments on Account work (and why they’re annoying)
You pay tax in three instalments:
31 January: Balancing payment for the previous tax year, plus first payment on account for the current year.
31 July: Second payment on account.
The following January: Final balancing payment once your actual tax bill is calculated.
The issue? Both payments on account are based on last year’s bill, not what you’ll actually owe this year. This means, if your earnings have dropped, you’re overpaying; if they’ve increased, you’re underpaying and will face a bigger bill in January.
This is why reducing your POA can seem attractive, but it’s also where people make expensive mistakes.
When reducing actually makes sense
You can legitimately reduce your POA if you can show your tax bill will be significantly lower than last year. Valid reasons include:
- You’ve lost a major client and your income is substantially lower
- You’ve switched from self-employed to PAYE employment
- You’ve taken a sabbatical or extended unpaid leave
- A significant part of your business has ceased trading
Unfortunately, “business is a bit quieter” or “I had a bad quarter” doesn’t cut it. You need real evidence of a sustained reduction.
The interest trap
As accountants, we see this catch people out time and time again.
- You reduce your POA based on a projection, then the tax year finishes differently than expected. Maybe you picked up new clients by September, or a big project came through, or your projection was simply off.
- Now your actual tax bill is higher than the reduced payments you made. HMRC will demand the shortfall, plus late payment interest at around 7.75% per annum, calculated from the date the original payment was due.
Example: if you underpay by £5,000 on both your January and July payments on account …but then actually underestimate and owe that tax anyway…you’re looking at an interest charge of around £581. Underpay just the July instalment? That’s still about £194 in interest.
Then in January, you’re not just paying the interest. You’re also paying the tax you knocked off your payments on account, plus your balancing payment, plus your first payment on account for the next year.
That “saving” has actually cost you money in interest, plus the stress of a surprisingly high January bill. Not good.
Use real data, not guesses
Our golden rule? Never reduce based on a forecast. Use actual figures to project the full year. Even then, be conservative. If you think your income might be £80,000 down, project it as £75,000 down. That way, if you’re wrong, you’re wrong on the safe side.
In practice, reducing your January payment on account often involves guesswork based on a few months’ data. But by July, you have much better information. You can make a more accurate decision, especially if you give your accountant the data to prepare your tax return before the July deadline.
Most accountants won’t submit a reduction request without current trading data, anyway. We’d rather you keep the payment and get a refund in January than reduce it and face interest charges later.
The commercial cashflow conundrum
Having said do proper estimates and only reduce your payments on account for justified reasons…there is another side of the coin. Sometimes you just have to protect your cashflow and look for ways to borrow money to make ends meet.
If you’re facing a summer downturn with low income and high expenses, you might need to weigh up your options. How does the interest you’d owe HMRC compare to borrowing elsewhere? If £581 in interest is cheaper than a loan, then reducing your payment on account might be the pragmatic commercial decision.
Not paying HMRC on time can be easier than getting a loan approved. But remember: you still owe that tax; both the tax and the interest will land just after Christmas. And you run the risk of a penalty on top of the interest charge, which can make this a very expensive cashflow mistake!
Can HMRC refuse to reduce a Payment on Account?
Yes. And they do.
Technically, you apply and ask for a reduction. If HMRC think your reasons are invalid, they can reinstate the payment on account based on 50% of your previous tax bill.
What’s more, HMRC can impose a penalty for “fraudulently or negligently” applying for a reduction. So don’t take liberties, they’re not fans of that.
Remember to document everything
If you do reduce your payment on account, keep the evidence. Your trading accounts for April-June, the client contracts you’ve lost, the change in business structure…whatever justifies the reduction. Why? Because if HMRC questions it, you need to be able to defend it.
Thinking about reducing your July payment? Get in touch before you submit. We can review your actual trading performance and forecast the full year properly, so your reduction is based on real numbers, not guesswork. |
