If you are self-employed, as a sole trader or in partnership, and if we assume that your business year end is 31 March, then the profits you earn in the year to 31 March 2014 will form the basis of your tax payments on account for the tax year 2014-15 (unless the year to 31 March 2014 was your final year of trading).
Problems may arise if profits, year on year, fluctuate significantly; either up or down.
Your tax payments as a self-employed person consist of two payments on account and a final settlement on the 31 January following the end of the relevant tax year. For example you will make equal payments on account for the tax year 2013-14 in January and in July 2014. If this is insufficient to cover the total tax and Class 4 NIC due then you will have a top up payment to make in 31 January 2015.
Payments on account are initially based on your Self Assessment liability for the previous tax year – in the above example, the January and July 2014 payments will be based on your actual taxes due for 2012-13.
If your trading profits have not increased or reduced significantly, the payments on account will usually cover tax due and there will be perhaps a small difference, under or overpaid, that will need to be sorted out in the following January.
However, if your profits have significantly increased or reduced, then cash flow considerations need to be taken into account.
If your profits for the year to 31 March 2014 are likely to be higher than the previous year:
In this case any payments on account you make January and July 2014 are unlikely to cover taxes due for 2013-14 and a balancing payment will arise on 31 January 2015.
If your profits for the year to 31 March 2014 are likely to be lower than the previous year:
In this case any payments on account you make in January and in July 2014 are likely to be more than you need to make to cover taxes due for 2013-14 and a balancing overpayment will arise on 31 January 2015. This can be addressed by making an election to reduce the payments on account to a more appropriate amount.
If either of these scenarios is likely to apply to your self-employed business profits, we advise you to have your accounts drawn up as soon as possible after your year end. The tax advantages can be summarised as:
- If your profits have been increasing, you will have the maximum period to create a cash reserve to cover any shortfall in taxes due on 31 January 2015.
- If your profits have been reducing, you can make an election to reduce the second payment on account for 2013-14, due on 31 July 2014.