Contractors who have experienced a sudden fall in income may need to negotiate a reduction of their payment on account with HMRC because it no longer accurately reflects their projected tax liability.
“Contractors’ incomes may fall for a variety of reasons, which could reduce their tax liability or take them out of needing to make payments on account,” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore LLP.
“Negotiating a reduction is usually straightforward, but it is important to get the timing right and follow correct procedure to avoid a challenge by HMRC,” he adds.
Why contractors’ payments on account might reduce
Contractors with income above £42,475 (correct at the time of writing) that take them into the higher rate tax band, and who might have income from other sources, such as rental properties, are required under Self Assessment to make a payment on account during the current tax year for future income tax and National Insurance liabilities.
“The payment on account is calculated based on the personal income tax liability from the previous year,” says Abbott. “If a contractor’s income has been high enough to take them into the higher or top rate bands, or there has been income from other sources such as rents, then the payment on account could be quite substantial.
“Should a contractor’s income drop suddenly, perhaps due to a prolonged period between contracts, or a rental property being empty, the payment on account may be overstated.”
Unless told differently, HMRC will assume that the contractor’s tax liability is the same and will issue a tax demand for payment on account. That’s why a contractor should inform HMRC that circumstances have changed. And, unless the contractor responds, HMRC will continue to chase the money and treat it as an unpaid tax bill, causing the contractor unnecessary hassle and stress.
Informing HMRC of changes – timing is important
“The mechanism of informing HMRC that the tax liability, and corresponding payment on account, is less than previous years depends on the timing in the tax year,” continues Abbott.
“If a contractor has not submitted a Self Assessment tax return, then there is a section on the tax return where it is possible to specify the payment on account, with an explanation. In most cases, this will automatically override the default calculation by HMRC based on the previous year’s income tax liability.”
Negotiating a reduction is usually straightforward, but it is important to get the timing right and follow correct procedure to avoid a challenge by HMRC
James Abbott, Abbott Moore LLP
When HMRC receives the contractor’s Self Assessment tax return, and sees that the contractor is forecasting a fall in income, it will adjust the payment on account accordingly. In Abbott’s experience, HMRC rarely challenges such requests.
Form SA303 Claim to Reduce Payments on Account
However, if a contractor has already submitted their tax return and income drops deeply and suddenly, then there is the option of submitting form SA303 Claim to Reduce Payments on Account.
Abbott explains: “Contractors must submit this, with an explanation as to why the payment on account is being reduced. HMRC rarely disagrees with a claim, although it can come back to the contractor requesting further justification.”
And, according to Abbott, the other reason HMRC rarely challenges a request is because if a contractor overestimates the reduction in their payment on account, and does underpay, they will have to pay interest on the difference. “Reducing payments on account is not a solution to lowering a tax bill.”