What Is PAYE and How Does It Work?
PAYE stands for Pay As You Earn. It is the system HM Revenue and Customs uses to collect Income Tax and National Insurance from employees.
Employers manage PAYE through their payroll. Before paying an employee, the business works out the required deductions. It then pays the employee their net wage and sends the deductions to HMRC.
For business owners, PAYE is an important part of employing staff. You must calculate pay correctly, submit reports on time and keep suitable payroll records.
How Does PAYE Work in the UK?
Each time you run payroll, you start with an employee’s gross pay. This is their pay before tax and other deductions.
Your payroll system then calculates deductions such as:
- Income Tax
- Employee National Insurance
- Workplace pension contributions
- Student or postgraduate loan repayments
- Other agreed deductions
The employee receives the amount left after these deductions. This is known as their net pay.
The business may also need to pay employer National Insurance and workplace pension contributions. These costs are separate from the amount deducted from the employee.
Payroll software usually completes the calculations. It uses each employee’s pay, National Insurance category and tax code to work out the correct amounts.
What Is a PAYE Tax Code?
A tax code tells an employer how much tax-free income an employee may receive before Income Tax is deducted.
HMRC normally provides the tax code. The code may change when the employee’s income or personal circumstances change. For example, it could change if they receive taxable benefits or have more than one job.
Most people with one job or pension currently use the tax code 1257L. However, business owners should always use the code supplied by HMRC rather than assuming every employee has the same code.
When a new employee starts, you will normally use the details from their P45. Where no P45 is available, the employee should complete a starter checklist.
Reporting Payroll to HMRC
Employers report payroll information through Real Time Information, often called RTI.
A Full Payment Submission, or FPS, shows each employee’s pay and deductions. It must normally be sent to HMRC on or before the employee’s payday.
An Employer Payment Summary, or EPS, may also be needed. This can be used to report that no employees were paid or to claim certain reductions. An EPS that affects the amount due should normally reach HMRC by the 19th of the following tax month.
Paying PAYE to HMRC
Your PAYE bill may include Income Tax, employee National Insurance, employer National Insurance and other payroll deductions.
Monthly payments normally need to reach HMRC by the 22nd of the following tax month when paid electronically. Employers allowed to pay quarterly normally face a deadline of the 22nd after the quarter ends. Earlier deadlines apply to payments made by post.
Late reports or payments may lead to interest and penalties.
What Should Business Owners Know?
Payroll is not just about paying wages. Employers must also provide payslips, keep payroll records, process starters and leavers, apply HMRC notices and complete year-end duties.
Small errors can cause incorrect wages, unexpected PAYE bills or problems for employees. The rules can become more complex when a business has directors, benefits, irregular hours, statutory pay or employees on different pension schemes.
An accountant can help you register for PAYE, set up payroll software and process wages. They can also submit reports, calculate deductions, prepare year-end documents and check what you owe HMRC.
Professional payroll support can reduce the time spent on admin and lower the risk of missed deadlines. It also gives business owners more confidence that staff are being paid correctly and PAYE rules are being followed.
