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What does PAYE mean?

July 28, 2021

It may not be one of the most enjoyable parts of running a business, but processing payroll is an essential job for employers. It's the responsibility of employers to calculate and record the PAYE (Pay As You Earn) and National Insurance Contributions that they and their employees need to pass through to HMRC.

Everyone has to pay Income Tax if they earn over a certain amount. For the tax year 2019/2020, Income Tax made up £194 billion of £828 billion of the government's income and was the government's biggest income for the tax year. National Insurance, another mandatory salary deduction, came in second with a contribution of £145 billion.

It's important that PAYE records are kept up to date so that HMRC can calculate your company's PAYE contributions and administer penalties for late payments. You can either hire a payroll advisor, use payroll software to do the calculations yourself or automate your payroll with Ember in a few simple steps, giving you one less thing to worry about.

Although employers have a responsibility to maintain payroll, HMRC issues tax codes to help you or your employees work out the PAYE tax. HMRC can also issue emergency tax codes if you start a new job, and you can find out your tax code by logging into or registering with Government Gateway.

What does PAYE mean?

PAYE stands for 'pay as you earn'. It's an income tax system that takes tax from your salary on a regular basis, with the amount deducted determined by how much you earn. PAYE is paid to HMRC by the company's employer before the payslips are given out.

You must register for PAYE if you run your own business and have employees. However, you do not need to pay PAYE if you are self-employed. The alternative for those that are self-employed is Self Assessment, which is paid once or twice a year.

In the following article, we'll talk you through how PAYE is calculated, how to operate it as an employer and other things to look out for.

How is PAYE calculated?

PAYE is a tax that is based on your income and your personal allowance entitlement, which is the amount that you'll receive tax-free each year. To figure this out, you'll be given a tax code, which will tell you or your employee how much tax should be deducted. The following are the salary boundaries for personal allowance and the percentage that PAYE will be calculated at for the tax year 2021/2022:

  • £0 to £12,570 is certified as personal allowance and is tax-free
  • £12,571 to £50,270 is the basic rate and is taxed at 20%
  • £50,271 to £150,000 is the higher rate and is taxed at 40%
  • £150,001 and above is the additional rate and is taxed at 45%

These rates apply everywhere in the UK except for Scotland.

Who qualifies for PAYE?

Anyone earning over £120 per week needs to pay through PAYE. If you or your employee earns less than this, they don't need to be registered for PAYE but they must still be named on the payroll.

Employers should operate PAYE as part of the payroll. Any payments or deductions must be reported to HMRC on or before payday.

PAYE online

New employers should get a login with HMRC when you register online. However, you can also register for HMRC's PAYE Online, even if you don't already have a login. You can do so by registering with your PAYE reference and Accounts Office reference.

PAYE Online can be used to access notices that HMRC sends you. This can include information about your employees such as tax codes, student loan notices and National Insurance. You can also be notified about late payments and information that you need to update.

You can download the HMRC application called PAYE Desktop Viewer. The application can be particularly helpful if you have large volumes of employee tax codes to view and sort. You can also access PAYE Online through some payroll software.

PAYE Desktop Viewer can be downloaded for Windows, Mac and Linux.

Reporting and paying PAYE to HMRC

As an employer, you must pay your PAYE bill on time to HMRC. If you pay quarterly, you must pay on the 22nd of the month following the end of the quarter.

You can pay online or by telephone banking for next or same-day payments. Debit or corporate credit cards can take up to three days to process. You should send cheques by the postal deadline of the 19th so that they have enough time to arrive.

HMRC will charge you if you do not make a PAYE payment or it is not paid in full, with the interest rate varying based on the number of defaults you have in the tax year. The following rates apply to payments that are due monthly or quarterly.

  • One to three defaults are charged at 1%
  • Four to six defaults are charged at 2%
  • Seven to nine defaults are charged at 3%
  • Ten or more defaults are charged at 4%

The interest will be charged on a daily basis from the date that the payment was due until you eventually pay it back in full. If the rates are still unpaid after six months, you will be charged an additional 5%. A further 5% will be charged after 12 months if you have still not paid. These additional rates also apply if your tax amounts are due annually or occasionally. The penalty date is usually the day after the PAYE due date.

The penalties apply for any late payment, even if you only miss one in the tax year.

What should the PAYE bill include?

The PAYE bill should include the Income Tax deductions you have deducted from your employee's salary. The bill might also include the National Insurance contribution and any student loan repayments by the employee.

What are the sections on my payslip?

Here is a breakdown of what you are likely to find on each of your payslips:

  • Gross pay – this is the full amount that you have earned. The total is calculated before taxes such as PAYE and National Insurance have been deducted.
  • Net pay – this is the total you have earned after the taxes have been deducted
  • Break down of variable and fixed deductions –this will include the amount you have paid on each of the various taxes, including PAYE and student loan repayments
  • Total hours worked

Employers might choose to add the following information onto a payslip:

  • Tax code
  • National Insurance number
  • Pay rate (annually/hourly)
  • Any extras, such as tips, bonuses and paid overtime

Will I get a PAYE refund?

You may be entitled to a tax return if you overpay your tax. If the mistake was due to an incorrect Full Payment Submission (FPS) or an Employer Payment Summary (EPS), the correction should be verified on your next regular report. If the overpayment was due to a mistake on your part, you should balance your account by paying less PAYE on your next tax bill.

You should contact HMRC if you think your tax code is incorrect and they can issue you a refund. This can be done over the phone or by filling out a form on the HMRC website for your tax claim.

If you have paid too little tax, you need to pay the remaining balance as soon as possible. You may encounter a penalty because of the late payment and be issued with interest on top of your owing amount.

How does PAYE work with my pension?

PAYE is used to pay Income Tax for those receiving a pension. You must send HMRC a Self Assessment if your only income is a state pension. You should receive a yearly statement from your pension provider to let you know how much is in your pension pot.

There are two types of arrangements that allow some tax relief on pension contributions. They are called 'relief at source' and 'net pay'. Tax is deducted at two stages of the payment process – either before or after tax is deducted.

Relief at source

Relief at source means that your employer can deduct your pension from your net salary after the tax and National Insurance deductions have been made. Your pension provider will then add tax relief of 20% (the basic rate) to your pension pot.

Net pay

Whereas relief at source deducts your pension after tax, net pay will deduct the money before tax. You will therefore pay tax on your salary, minus the money that was deducted for your pension pot. This method means that you will pay less tax and get more take-home pay. You will also have complete tax relief on your pension contribution.

Do I pay tax on company benefits?

Your employer may offer you extra benefits with the company. In most cases, you will have to pay tax on these benefits. These benefits should be listed and sent to HMRC and then given to you by your employer at the end of the tax year. It is up to you as the employee to notify HMRC about any benefits that you have started or stopped receiving.

Medical Insurance

You will have to pay tax on insurance premiums if you receive medical insurance through your company. Some benefits might be tax-free, such as annual check-ups and insurance for when you're working abroad.

Loans

If you have a loan that is worth more than £10,000, you will have to pay tax. The tax will be paid on the interest rate difference between the official interest set by the Bank of England and the interest rate set by your employer.

Company Car

You will pay tax if you drive a company car for personal or work use. The tax is calculated based on the value of the car, for example, how much it would cost to buy and the fuel type. You can pay less for the company car if you only use it part-time, it emits lower CO2 or you already contribute to the cost.

It's important to remember to keep track of your PAYE records and adjust them depending on your employees', and your own, income.

How do I operate PAYE as an employer?

Employers need to deduct PAYE from their employees' salaries through the payroll. You can either do this yourself by using payroll software or pay for a payroll advisor to help you. Although you may choose the latter option, you are still responsible for keeping the records for your employees.

The following information is a step by step breakdown of how to set up payroll by yourself.

Setting up payroll

Firstly, you must register as an employer with HMRC. As previously mentioned, you also need to register your company with PAYE.

The most important part of running payroll is to make sure that you keep and file all relevant employee records. This will help HMRC to know which employees you have working for you and the correct amount that they should be taxed.

The payroll information will be sent by a Full Payment Summary (FPS). This will let HMRC see the tax and National Insurance deductions that you have made from your employees' salaries. It's important to remember that you have to make an FPS for each of your employees and that it correctly lists the tax amount that HMRC will be expecting to receive in full.

The Employer Payment Summary (EPS) has to be sent to HMRC if you haven't paid your employees within a pay period. Limited companies can also send an EPS if they have received Construction Industry Scheme (CIS) deductions.

If choosing to do payroll yourself, you will need to choose payroll software that processes the salaries of your employees and deducts the correct amount of tax. The tax, including PAYE and National Insurance, should be fully paid to HMRC.

Ember can sort out the payroll on your behalf and send it straight to HMRC. You can easily add new employee details and receive notifications of upcoming deadlines.

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Daniel Hogan

Daniel is a Deloitte-trained, fully qualified Chartered Accountant with experience in the finance software space. It was during his tenure managing a finance system in the UK that he grew dissatisfied with the lack of synergy and automation in the space, compelling him to co-found Ember.