Payments on Account - Paying Tax Upfront

[RichG]

Hi all,

I'm struggling to understand how payments on accounts work.

My scenario

I'm in my first year contracting. My accountant has given me a max available dividends that I can take for the remainder of the year using my P60 from my previous permanent employment. For sake of the example lets say thats £15,000. This should equate to the £41k before higher rate of tax.

My understanding therefore is that dividends that I take beyond £15,000 will be subject to the usual corporation tax @ 20% and personal tax at 25%. So lets say I take £35,000 of dividends, £15,000 is as per the max available, and then theres another £20,000 which will be taxed personally at 25% which will create a £5,000 personal liability for the year.

1.

Is that correct so far?

2.

With this in mind I heard I also have to keep back 50% of this personal liability to pay next years tax upfront - known as payments on account? This in the current running example would be £2,500. However my accountant has muddied the water by informing me its the full amount, so £5,000 + another £5,000. From reading online it seems the accountant may be right but the second £5,000 is split into two bills of 50% one paid in Jan and July? Can someone clairfy?

3.

As personal liability is calculated on earnings such as salary and dividend, is it possible to take a loan from the business instead thus reducing the amount... so in the example above where I have taken £35,000 dividends, if instead that was £25,000 dividends and a £10,000 loan, because the £15,000 is tax free (see point 1), I now only have £10,000 @ 25% personal liability which would be £2,500, with £1,250 paid upfront in jan and again in july. is that right?

[TheCyclingProgrammer]

Your numbers seem correct but remember you pay corporation tax on your company gross profit, not the dividend. So in order to have £20k of net profit to withdraw as a dividend, you would need to have £25k of gross profit (£5k CT). If you were over the higher rate threshold, that £20k would be effectively taxed at 25% so yes, you would have a further £5k income tax to pay.

Your accountant is right that your payments on account are based on the previous years tax bill but you would pay this in two parts. Half in Jan and half in July.

You could take up to £10k as a directors loan which would half your tax bill and your payments on account but you need to be aware of the implications of an overdrawn loan account. It has to be repaid within 9 months of your company year end and cannot exceed £10k without further BIK implications.

In short, if all you want to do is take a £10k directors loan, then pay it off ASAP by declaring a £10k dividend at the start of the new tax year, where it will no longer be taxed at the higher rate, this will work just fine. But only if you then intend to stay under the higher tax limit in the next tax year, otherwise you're just delaying the inevitable.

Finally, if you don't intend to take dividends above the higher rate threshold in the next tax year, and this year its just a one off, then you could just apply to reduce your payments on account to nil.

[RichG]

Thanks for taking the time to write an easy to understand and clear reply, and correcting my point about gross tax profit around the corporation tax.

A follow up question.

Am I right in the following:

Personal tax year runs April to April, this is when I will do self assessment and get a bill for income tax.
Business year end runs from business start date (in my case july), yearly and thats when I will get a bill for corporation tax.

Both bills don't require payment immediately. These two entities may as well be treated separately?

So April 2015 they will work out my liability (for April 2014 - April 2015) and then using that figure make a bill for me which will include the liability and then also include the payments on account part which needs to be paid in two installments, July, January. Is that July 2015, Jan 2016 OR Jan 2016, July 2016?

I will likely always be spending over the threshold due to high London living costs. But I may be moving north next year. On those grounds next years living costs may be less and living under the threashold may be possible. Accordingly your comment about delaying the inevitable is that in relation to instantly losing out on 10k of next years dividends by repaying the business loan in the first month?

[TheCyclingProgrammer]

Yes, if you take a loan now and pay it off with a dividend in the new tax year, you will likely be in a similar position the following year anyway.

It's you who declares your personal tax liability when you complete your tax return. For the 2014-15 tax year, you can submit that from April but by the end of Jan 2016, which is when the tax will be due (9 months in arrears) and your first payment on account. The second will be July 2016. These payments are to ensure you aren't paying tax 9 months in arrears going forward (this only happens for the first year). Finally you may have a balancing payment if you've over or under paid in Jan 2017.

Likewise your CT is due 9 months after your company year end.

Try to keep personal and company tax liabilities separate.

[SueEllen]

You are getting confused.

Your business is not you. It is a separate legal entity with it's own bank account. This legal entity, which we can call a body, has corporation tax due 9 months after year end.

You, RichG, have to do self assessment and pay any tax you owe to HMRC personally. The body can't pay it for you out of its bank account.

However the body can put money in RichG's bank account in the form of wages, if you are an employee, and dividends, if you are shareholder, to do whatever you like with including to pay RichG's tax bills.

[RichG]

Thanks to you both. Excellent replies. Thats cleared that up. Cheers.