When you are self-employed you calculate, or have calculated for you, the amount of tax and National Insurance that is payable to HMRC. Once your tax liability is over £1000 per year then HMRC start wanting Payments on Account from you. It is quite complicated to understand and confuses many people.
The idea behind it is to spread out your tax liability. The bit people don’t like is that it is payable in advance.
Year 1 self-employed your tax liability is £800 – You need to pay £800 to HMRC on 31st January
Year 2 self-employed your tax liability is £1500 – you need to pay £1500 to HMRC by 31st January BUT you also now need to pay payment on account for your next year’s tax.
The way that it is worked out is that HMRC assume your tax will not change so you need to pay over half the liability in January and half on 31st July.
So now the amount you need to pay on 31st January is £1500 (for year 2) + £750 (towards year 3) this equates to £2250 on January 31st and then on 31st July you need to pay £750 again.
Year 3 self-employed (you are doing well) and your liability is now £2500. You have already paid £1500 in your payments on account, so you now owe them the difference on 31stc January which is £1000 + your first payment on account of £1250. I.e. £2250 and then £1250 on July 31st
If your tax liability does not change in year 3 and stay at £1500 per year you would just continue paying the £750 twice a year and have no balancing payment.
Once you are running with payments on account it is quite easy to follow. Unfortunately, when you first fall into this bracket you have to pay the equivalent of 2 years’ tax in what feels like 1 year.