What is PAYE in brief?
PAYE is an acronym for Pay As You Earn. This is the system of tax collection whereby your employer or pension provider is required to deduct Income Tax and National Insurance contributions before they pay your wages or pension.
Employees whose taxes are paid through PAYE, do not need to pay further tax to HM Revenue & Customs (HMRC). It’s also up to your employer to pay the tax to HMRC.
However, self-employed individuals have to file a tax return and pay income tax, and national insurance directly to HMRC.
This article will delve into how PAYE works and operates and the implications of PAYE for employees.
How does PAYE operate?
PAYE is a method used by HMRC to collect income tax and National Insurance directly from employees’ wages or pensions.
Every business operating in the UK is required to adhere to PAYE regulations. It is the employer’s responsibility to deduct the appropriate tax and National Insurance amounts from employees’ paychecks and submit them to HMRC.
The amount of tax deducted from employees’ paychecks depends on the kind of work they do and how much they earn.
Employees who earn between up to £37,700 annually will be charged at the basic rate of tax, which is 20%, and anything from £37,701 to £125,140 is charged at the higher rate of 40%. Income over £125,140 is taxed at 45%, known as the additional rate.
How PAYE Works in the UK
Here is a step-by-step guide on how PAYE works.
1. Business registration with HMRC
To obtain a PAYE reference number, businesses must register with HMRC as employers. The PAYE reference number is essential for payroll processes.
2. Employees' tax code
HMRC provides a personal tax code for every employee through the PAYE system. The tax code shows how much amount of income an employee is allowed to receive without paying tax and other factors such as personal allowance, benefits, and other income services.
3. Employer’s role
Employers will seek details from their employees such as National Insurance number, and tax code. They rely on the tax code issued by the HMRC to determine the correct amount, tax rate, and allowances. This information helps calculate and deduct income tax and National Insurance from employees’ gross pay. Employers also handle other deductions, such as student loan repayments.
4. Payroll setup
Employers can set up payroll by either selecting payroll software to record employee details, calculate pay, and handle deductions or outsource the service. The software will help you manage payroll efficiently and ensure compliance with tax regulations.
5. Calculate pay and deductions
Use your chosen payroll software to calculate employees’ pay based on their working hours, tax codes, and other factors. Deduct income tax, National Insurance, and any other applicable deductions.
6. Report to HMRC
Before the first payday, report employees' pay and deductions to HMRC. It includes details of employees' pay, tax and National Insurance deducted, and other deductions like pension contributions or student loan repayments. Ensure timely submission to avoid penalties.
7. Employer Payment Summary (EPS)
Employers should send an EPS if there are any additional deductions or recoveries, such as statutory maternity or paternity pay, to HMRC. This information is always not included in the FPS.
8. Paying HMRC
Pay the tax and National Insurance contributions you owe to HMRC. This payment is usually due by the 22nd of the following month (or the 19th if paying by post). Remember to meet payment deadlines.
9. Provision of P60
At the end of the tax year, employers must provide a P60 form showing employees' annual earnings and deductions. This happens at the end of the tax year, 5 April, when employers reconcile total deductions with HMRC.
10. Adjustments and refunds
If there are discrepancies, adjustments are made. Employees may receive tax refunds if they overpaid during the year.
Do I need to register for PAYE as an employer?
As an employer, you will need to register your company for PAYE if you operate under the Construction Industry Scheme (CIS) as a contractor and if any employees including directors:
- · Are paid £123 or more per week
- · Receive a pension.
- · They’ve had another job.
- · Receive expenses or other employee benefits.
- · They’ve received a jobseeker’s allowance, employment, and support allowance, or incapacity benefit.
How to register for PAYE
Gather required information: Collect necessary details about your business, including your company’s name, address, and contact information.
Visit HMRC’s website: Go to the HMRC registration page and follow the steps to create your account. You’ll receive a code via email to complete the registration process.
Choose online or offline registration: Most businesses should register online using payroll software. For offline registration, you can apply by filling out the necessary forms and posting them to HMRC.
Register as an employer: Once registered, you’ll receive your PAYE reference number from HMRC. This number is essential for payroll processing and reporting.
Information needed to register for PAYE include:
- · your name and address
- · contact details
- · type of business (for example sole trader)
- · number of employees you expect to employ
- · date you want the PAYE scheme to start (‘today’ is the default)
- · date of first payday (if known)
- · your National Insurance number
When should you Register for PAYE?
You should register for PAYE in the UK before your first payday. It’s essential to allow sufficient time for the registration process, which can take up to 30 working days. Note that you can't register too early. You can register within two months of when you plan to start paying your staff.
Once registered, you’ll receive your employer's PAYE reference number from HMRC, which you’ll need for payroll processing and reporting.
If you pay an employee before you get your employer's PAYE reference number, you should:
- · Run payroll.
- · Store your full payment submission.
- · Send a late full payment submission to HMRC.
Do self-employed individuals pay PAYE?
Self-employed workers are not paid through PAYE and they do not have the rights and responsibilities of an employee. Self-employed workers need to declare their earnings through a Self-Assessment Tax Return.
Income and expenses: This refers to income that self-employed people can earn from the business they conduct or through freelancing. In other words, you can subtract from the income only specific business expenses to find the taxable profit.
Self-Assessment Tax Return: Every year you have to fill a Self-Assessment Tax Return form. State your gross amount of income, expenditure, and any other relevant details through which HMRC will determine your tax to be paid.
Tax payment: Anyone who is self-employed will have to settle their tax bills through the HMRC. Payments are usually due by January 31st following the end of the tax year.
National Insurance Contributions (NICs): You will be required to contribute Class 2 and Class 4 National Insurance Contributions (NICs). Class 2 NICs are a flat weekly amount, while Class 4 NICs are based on your profits.
In conclusion, being on PAYE provides better stability and job security for employees than freelancers. Employees do not need to handle large tax bills at the end of the year. PAYE promotes financial stability and compliance with tax regulations.
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