If you run a small business which is not incorporated (not a limited company), it is important to know how much your tax is likely to be and when your tax payments are due.
This is not an easy subject to explain, let alone understand, which is why you should have a good relationship with your accountant. Your accountant should know your business, maximise the claims available to you and let you know well in advance about tax liabilities becoming due.
That said, it is important that you broadly understand how your tax payments are calculated because, without this knowledge, it is difficult to plan your cash flow.
In this blog I will explain how tax works for the self-employed.
Accounts and my “adjusted profit”
The profit in your accounts is only part of the story. Some costs charged in the accounts may not be allowable for tax, so your accountant will adjust the profit. Common examples include:
- Depreciation (and some amortisation)
- Business entertaining
- The private element of expenses, such as motor and telephone costs
Tax relief may also be available for expenditure which is not deducted as an ordinary expense in the profit and loss account. For example, qualifying vehicles and plant are normally relieved through capital allowances rather than being deducted directly from profit.
Personal pension contributions do not normally reduce trading profit. Instead, tax relief is generally given separately when your overall Income Tax liability is calculated.
It’s all about timing
The legislation introducing the new tax-year basis received Royal Assent on 24 February 2022 as part of Finance Act 2022. The 2023/24 tax year was the transition year, and the new rules took effect from 6 April 2024 for the 2024/25 tax year onwards.
Self-employed profits are now taxed on a tax-year basis. This means that you are taxed on the profits arising between 6 April and the following 5 April, regardless of the date to which your accounts are prepared.
If your accounts are prepared to 31 March or 5 April, the figures will normally correspond closely with the tax year. If you use a different accounting date, profits from parts of two accounting periods may have to be apportioned to arrive at the taxable profit for the tax year. In some cases, estimated figures may initially be needed if the later accounts have not been completed when the tax return is submitted.
Your adjusted trading profit is added to any other taxable income for the tax year. After taking account of personal allowances and any available reliefs, your total Income Tax and National Insurance liability is calculated.
Any balancing payment is normally due by 31 January following the end of the tax year. For example, the balancing payment for the tax year ending 5 April 2026 is due by 31 January 2027. Any payments on account already made are deducted when calculating the amount still payable.
How are payments on account calculated?
Payments on account are advance payments towards your next Self Assessment liability. Each payment is normally half of the previous year’s relevant Income Tax and Class 4 National Insurance liability.
Payments on account are not normally required if the relevant amount is £1,000 or less, or if at least 80% of the total tax liability was collected at source—for example, through PAYE. Capital Gains Tax and student loan repayments are not included in the calculation.
If your income is expected to fall, it may be possible to apply to reduce your payments on account, although interest can be charged if they are reduced too far.
When are payments on account due?
The first payment on account is due on 31 January during the tax year and the second is due on 31 July following the end of that tax year.
So what can cause a problem?
Fluctuating profits can cause problems.
If taxable profit is low in one tax year, the payments on account towards the following year may also be low. If profit then rises, a much larger balancing payment may be due on the next 31 January. On that same date, the first payment on account for the new tax year will usually also become due.
For example, suppose taxable profit is low in 2024/25 but substantially higher in 2025/26. The payments on account made in January and July 2026 may not cover much of the 2025/26 liability. The remaining balance will be due on 31 January 2027, together with the first payment on account towards 2026/27. A second payment on account will then follow on 31 July 2027.
A significant purchase of qualifying plant or a commercial vehicle can contribute to these fluctuations because capital allowances may reduce taxable profit in one year but not the next.
The solution?
Keep your records up to date and know where you stand financially. This helps you forecast both the balancing payment and the payments on account before they become due.
The best way to achieve this is to use the available tools and keep in contact with your accountant. If you are not using, or fully benefiting from, cloud accounting software such as Xero, you may find our post on choosing the right cloud accounting software useful.
This article gives a general overview only. The precise calculation depends on your circumstances and the tax rules applying to the relevant year.