Understanding payments on account is crucial for UK small business accounting and tax compliance. If you’re self-employed or earn income outside of PAYE, this system requires you to pay your tax bill in advance rather than one lump sum.
This can catch many business owners off guard, potentially causing cash flow problems if not adequately planned for.
This guide will walk you through everything you need to know about payments on account, helping you manage your tax obligations efficiently while maintaining healthy business finances.
What are payments on account?
Payments on account are advance payments towards your next tax bill, typically made twice a year on 31 January and 31 July. Each payment equals 50% of your previous tax bill.
HMRC implements this system for anyone whose self-assessment tax liability exceeds £1,000 in a tax year, unless more than 80% of your tax was deducted at source (such as through PAYE).
This approach helps spread the tax burden throughout the year rather than requiring one large payment, though it does mean you’ll need to budget carefully for these predetermined deadlines.
When do payments on account apply?
Payments on account apply when your self-assessment tax bill is over £1,000 and less than 80% of your total tax liability is collected at source.
For example, if you’re self-employed and your 2023/24 tax bill comes to £5,000, you’ll need to make two payments on account of £2,500 each for the 2024/25 tax year.
These payments function as an estimate based on your previous year’s income, operating under the assumption that your tax liability will remain relatively consistent year-to-year.
How to calculate your payments
Calculating your payments on account is straightforward – each payment equals half of your previous year’s tax bill. For instance, if your 2023/24 tax liability was £6,000, each payment on account for 2024/25 would be £3,000.
However, if this is your first year making payments on account, your January payment will include both your full tax bill for the previous year plus the first payment on account for the current year.
This “double payment” often surprises new business owners, making proper small business accounting practices essential from day one.
Managing cash flow around payment deadlines
The payment on account system requires disciplined financial management. Set aside a percentage of your income throughout the year specifically for tax obligations.
Many small business owners find it helpful to maintain a separate tax savings account where they deposit approximately 25-30% of their profits.
Accounting software can help estimate your tax liability and create reminders for upcoming payment deadlines. Planning is particularly important given that the January payment coincides with post-Christmas financial pressures.
Adjusting payments when income changes
If you expect your income to decrease in the current tax year, you can apply to reduce your payments on account. This is done through your HMRC online account or by completing form SA303.
While this can provide immediate cash flow relief, exercise caution when estimating your income reduction. If you underestimate and reduce your payments too much, HMRC will charge interest on the underpayment once your actual tax return is submitted.
Always maintain accurate bookkeeping to support any adjustments you request.
Late payment penalties and interest
Missing payment on account deadlines triggers HMRC’s penalty system. Interest accrues immediately on late payments, currently at 7.75% (as of April 2025).
After 30 days, a 5% penalty is applied to the outstanding amount, with additional 5% penalties at six and twelve months. These penalties compound quickly, making timely payments crucial.
If you anticipate difficulty meeting a deadline, contact HMRC proactively to discuss payment options before penalties accumulate.
Using digital tools for tax management
Modern small business accounting solutions like Xero offer significant advantages for managing payments on account. These platforms can track income throughout the year, estimate tax liabilities, and generate reminders for upcoming deadlines.
Cloud-based systems provide real-time financial visibility, allowing you to monitor your tax position continually rather than facing surprises at year-end. Many also connect directly with HMRC’s Making Tax Digital system, streamlining the entire compliance process.
Planning for the balancing payment
When you submit your self-assessment return, you’ll calculate any difference between your payments on account and your actual tax liability. This “balancing payment” is due alongside your first payment on account for the next tax year on January 31st.
If your income increased substantially, this balancing payment could be significant.
Building a tax reserve throughout the year helps manage this potential expense. Monitoring your profits quarterly enables you to anticipate and prepare for larger-than-expected tax bills.
By Emma Green-Watson
Advertising feature with Xero.com
