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What Does It Mean To Be PAYE In The UK

what is paye uk

The term “PAYE” stands for “Pay As You Earn” and refers to the system that employers in the UK use to deduct tax and National Insurance contributions from employees before paying their wages or salaries. Being paid under PAYE means that the responsibility for calculating tax and reporting it to HM Revenue & Customs (HMRC) lies with the employer, rather than the employee having to complete annual self-assessment tax returns.

Who Needs To Know About PAYE

All employers in the UK are legally required to register with HMRC and operate PAYE for any employees they take on. So if you are running a business and plan to employ staff, it is essential that you understand what PAYE is and how it works. Self-employed contractors and freelancers do not fall under the PAYE system, but employees on your payroll do.

As an employer with staff paid under PAYE, you need to:

  • Register with HMRC as an employer
  • Deduct tax and National Insurance from employees’ pay
  • Report details of PAYE deductions to HMRC
  • Pay the deductions you have made to HMRC

Additionally, anyone taking on an employed role where they will be paid directly by an employer needs to be familiar with how PAYE impacts their take-home pay.

PAYE is something all UK employers and employees need to understand, as it forms the backbone of how tax and National Insurance contributions are managed for salaried workers, and getting it right is important for staying legally compliant.

How PAYE Works

When an employer takes on a new member of staff, they must register with HMRC as an employer and obtain a PAYE reference number. They will then use specific PAYE tax codes and tables provided by HMRC each tax year to calculate the income tax, National Insurance and Student Loan deductions to make from that employee’s gross pay each pay period.

These deductions are made before the net pay figure is calculated and paid to the employee. The cumulative deductions must then be reported and paid over to HMRC on a monthly or quarterly basis.

At the end of each tax year, employers have to file full payment summaries for each employee along with final employer annual returns, while employees receive P60 forms summarising their total pay and deductions for the year. These documents help HMRC reconcile records to ensure the correct income tax and National Insurance has been paid.

So in short, under PAYE:

  • Employers use tax codes and tables to make deductions from gross salary payments
  • These deductions are forwarded to HMRC regularly throughout the tax year
  • End-of-year returns check correct amounts have been deducted and paid

This means the administrative burden of dealing with income tax falls on employers rather than individual PAYE employees.

PAYE Tax Codes

A key part of operating PAYE involves using the correct HMRC tax codes. Every employee must be allocated a tax code, which essentially informs the employer how much tax-free allowance that person is entitled to each year.

The standard personal allowance for 2023/24 is £12,570. This means that a portion of every employee’s earnings is not liable for tax. HMRC issues tax codes to reflect allowances like this. For example:

  • 1257L – This indicates the employee’s tax-free personal allowance is the standard £12,570
  • BR – This is used when all income should be taxed at 20% with no allowance given

As circumstances change, employees may be sent revised codes during a tax year, which employers must then adjust calculations for. So regular communication with HMRC is key.

National Insurance Contributions

As well as deducting basic rate income tax at 20% based on the thresholds and personal allowances of each employee, employers must also deduct National Insurance contributions from salaries before they are paid.

National Insurance helps fund certain state benefits and the National Health Service. The rates and thresholds differ slightly from standard income tax.

In 2023/2024, the thresholds are:

  • No National Insurance is paid on the first £12,570 of earnings
  • 12% is paid on earnings between £12,571 and £50,270
  • The rate then increases to 2% on earnings above £50,270

So for higher earners, both 40% income tax and 2% National Insurance apply to some of their salary. Employers must deduct these amounts at source under PAYE.

When PAYE Deductions Are Due

Employers are obligated to forward all the income tax and National Insurance deductions they make to HMRC, either monthly or quarterly.

Monthly returns are due by the 19th of the following month for larger employers (those with over £1,500 PAYE deductions per month).

Quarterly returns can be made by smaller employers and are due by:

  • 5th May (covering 6th January – 5th April)
  • 5th August (covering 6th April – 5th July)
  • 5th November (covering 6th July – 5th October)
  • 5th February (covering 6th October – 5th January)

Missing deadlines can result in automatic penalties from HMRC so having accounting software or an accountant to help keep track of PAYE commitments is advisable.

Penalties For Incorrect PAYE Operation

HMRC has the power to impose financial penalties on employers who fail to operate PAYE correctly. Potential infractions include:

  • Failing to deduct PAYE and National Insurance from employee wages
  • Making errors that lead to deductions being too low
  • Not paying PAYE liabilities over to HMRC on time
  • Submitting inaccurate or late end-of-year returns
  • Not keeping adequate PAYE records for each employee

Penalties depend on the severity of the violation but can be hundreds or thousands of pounds if repeated problems occur over a period of time. Deliberate tax evasion could even result in criminal prosecution.

It is therefore vitally important for those running payroll and PAYE to understand and carefully follow HMRC guidance. Keeping detailed records, meeting deadlines, and querying issues early are key to avoiding penalties.

Payroll Software To Manage PAYE

Given the level of complexity around operating PAYE and payroll in an HMRC-compliant way, most employers choose to use dedicated software. Options like Sage Payroll, QuickBooks Payroll, Xero Payroll and Capium Payroll take care of:

  • Calculating income tax and National Insurance deductions in line with latest HMRC guidance
  • Generating payslips showing deductions
  • Producing monthly/quarterly returns to HMRC
  • Filing P60 and end-of-year paperwork
  • Keeping records to help employers meet obligations

This automates much of the PAYE admin burden. The cost of such software is generally modest compared to potential manual errors or non-compliance penalties. For most growing firms, outsourcing payroll completely can be wise.

Implications Of PAYE For Employees

While employers have to take on plenty of responsibilities under PAYE, what does being paid under PAYE mean for staff?

The main plus point is simplicity – with deductions made upfront each pay period, employees do not need to personally complete annual tax returns or make advance payments of tax during the year. PAYE means the tax due on your employment income is dealt with by your employer.

The only paperwork most basic-rate PAYE staff need to worry about is checking their P60 at year end or logging into their HMRC online account to confirm their employer has made the right deductions throughout the year.

Those with more complex finances still need to complete self-assessment tax returns each year. This includes:

  • Employees claiming expenses against their employment income
  • Higher earners subject to additional rate income tax
  • Anyone with substantial untaxed income from other sources like rental properties or investments
  • Self-employed earning income in addition to PAYE salary

So while PAYE handles most income tax for typical employees, some additional personal compliance cannot be avoided.

Options To Change Tax Codes

As outlined above, HMRC issues tax codes each year which let employers determine how much of an employee’s pay is covered by personal allowances, and therefore tax-free.

In rare cases, the initially allocated code may be too high or low. Employees do have some control here. Possible reasons to seek a correction include:

  • Starting part way through a tax year
  • Having more than one job at once
  • Changing jobs during a year
  • Having a large amount of untaxed income like savings interest

To alert HMRC if circumstances change, employees can update their personal tax account online, speak to HMRC by phone, or write via post. Revised PAYE codes should then be issued to employers.

Disputes Over PAYE Deductions

Sometimes mistakes happen on either side which see incorrect PAYE deductions made. Common examples include:

  • Employee feels too much tax has been deducted
  • Employer failed to account for changed personal circumstances
  • Errors in applying latest HMRC codes and thresholds

Employees should always talk directly with their employer in the first instance if they notice payroll issues, as this is often quicker to resolve. Should further investigation be needed, HMRC can liaise directly with both employer and employee to clarify where the discrepancy stems from.

If discussions prove deductions were incorrect, typically a refund would be arranged for the employee from HMRC in the event of overpayments. Equally, the employer would face backdated liabilities if underpayments occurred. So it is best for all parties to collaborate and resolve disputes promptly.

Additional PAYE Reporting Considerations for UK Employers

Beyond basic P60 forms and annual returns, there are some further HMRC reporting requirements that apply specifically to employers operating PAYE:

Real Time Information (RTI) – Under RTI, employers must electronically submit details of each employee’s tax and other deductions every time they get paid. This moves away from yearly reporting to providing data in real-time every pay cycle. Failing to file RTI returns on schedule can trigger penalties.

Form P11D – At the tax year-end, employers must file P11D forms to HMRC to report any taxable benefits, expenses or assets provided to employees which are not handled through payroll. This includes things like company cars, health insurance, discounted goods/services etc. P11Ds help ensure these types of remuneration are also taxed appropriately by individuals.

PAYE For Expat Employees

For UK employers hiring staff abroad or UK-based staffers working overseas temporarily, understanding how PAYE applies can be more complex. Various double taxation agreements come into play around where income tax and National Insurance is owed. It is critical employers get specialist guidance when running expat payroll to remain compliant.

PAYE and Company Ownership

One scenario where PAYE differs is if an employee directly owns shares in the business they work for, or receives additional income like dividends on top of basic salary. This necessitates annual tax self-assessment to reconcile what has already been deducted under PAYE versus final income tax owed. So PAYE does not always cover all taxes due.

Final Thoughts

In summary, PAYE stands for Pay As You Earn – the income tax and National Insurance deductions system used by all UK employers in respect of employees on their payroll.

Being paid under PAYE means tax and National Insurance contributions come directly out of your gross wages, with your employer handling all the administration and payments to HMRC on your behalf. This simplicity comes at the cost of having no control over what is deducted until your tax code can potentially be updated.

For employers, operating PAYE is compulsory but brings plenty of complexity in deductions calculations, deadlines and compliance. Using HMRC-recognised software or outsourcing payroll is the easiest means of staying on top of requirements and avoiding penalties.

So while the intricacies can seem daunting initially, PAYE is fundamentally there to ease the payroll and tax burdens for both employers and employees alike when staff are directly on the books. Understanding your key responsibilities is vital.

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