PAYE stands for Pay As You Earn. It is the system HMRC uses to collect Income Tax and National Insurance from wages. Employers deduct tax before paying employees. As a result, workers pay tax gradually throughout the year.
PAYE first appeared in 1944 during the Second World War. Since then, it has become the main way to collect tax from employees in the UK.
Who Needs to Register for PAYE
Employers must register for PAYE if any of the following apply:
- Employees earn £123 or more per week
- Employees receive pensions or expenses
- Employees receive company benefits or perks
Even if a business does not meet these standards, it must still keep accurate payroll records.
Employers should register before the first payday. However, they must not register more than two months in advance. HMRC can take up to 15 working days to issue an Employer Reference Number.
Some contractors must also register under the Construction Industry Scheme (CIS). Additionally, businesses with seasonal staff must follow PAYE rules when earnings meet the threshold.
Read more: Payroll Made Simple
How PAYE Works
Each payday, employers must complete the following steps:
- Calculate gross wages
- Deduct Income Tax and National Insurance
- Process other deductions (such as pensions or student loans)
- Submit payroll details to HMRC
- Pay the correct tax amount to HMRC
Employers must complete these steps on or before each payday. This process ensures that HMRC receives accurate and timely information.
Most employers pay HMRC monthly. However, smaller employers can apply to pay quarterly if liabilities stay below £1,500 per month.
PAYE Tax Rates
PAYE deductions depend on earnings and tax codes.
The main tax bands include:
| Tax Band | Income Range | Tax Rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% |
| Basic Rate | £12,571 to £50,270 | 20% |
| Higher Rate | £50,271 to £125,140 | 40% |
| Additional Rate | Over £125,140 | 45% |
You can think of these bands as steps. As income increases, each portion falls into a different band.
Only income within each bands is taxable at that rate. Therefore, moving into a higher band does not mean all income is taxable at that rate.
The Personal Allowance also reduces gradually for those earning over £100,000. It decreases by £1 for every £2 above this level.
Read more: Tax Bands and Tax Rates
Other Deductions
PAYE covers more than Income Tax and National Insurance, as employers may also deduct:
- Student loan repayments
- Workplace pension contributions
- Child maintenance payments
- Voluntary deductions
Student loan repayments usually apply once income passes a set threshold. The repayment rate depends on the type of loan.
Pension contributions usually apply automatically if the employee joins a workplace pension scheme.
All deductions must clearly appear on employee payslips. This helps your employees understand how you calculate their pay.
Read more: Understanding Your Payslip
PAYE for the Self-Employed
Most self-employed individuals pay tax through Self Assessment. However, some can pay small tax bills through PAYE.
This option only applies if:
- The tax owed stays below £3,000
- The individual already pays tax through PAYE
- The tax return meets submissions deadlines
This option can simplify tax payments and reduce the risk of missed deadlines. It can also spread payments across the year instead of paying in one lump sum.
Running Payroll and Reporting to HMRC
Employers can manage payroll using software or a payroll provider. Payroll software often simplifies calculations and reduces the risk of errors. However, the employer remains responsible for accuracy and compliance.
Each payday, employers must submit a Full Payment Submission (FPS). This report includes employee pay, tax and deductions.
If no payments occur in a tax period, employers must submit an Employer Payment Summary (EPS) instead.
Tax Codes
Every employee receives a tax code from HMRC. This code tells employers how much tax-free income an employee can earn.
The most common tax code is 1257L, which reflects the standard Personal Allowance of £12,570.
Tax codes may change if circumstances change, like if an employee:
- Starts a second job
- Receives Benefits In Kind
- Receives pension income
Employees should check their tax code regularly.
PAYE on Pensions
PAYE also applies to most pensions. Pension providers deduct tax before paying income. This process works in a similar way to employment income. As a result, pension income is taxed automatically.
The State Pension arrives without tax deductions. However, it still counts as taxable income. If total income, exceeds the Personal Allowance, tax becomes due.
If a person receives multiple pensions, HMRC usually assigns one provider to manage tax deductions.
Payslips and End-of-Year Forms
Employees receive a payslip each payday. This document provides a clear breakdown of pay and deductions.
A payslip usually shows:
- Gross pay
- Income Tax deducted
- National Insurance Contributions
- Other deductions (such as pensions or student loans)
At the end of the tax year, employers issue a P60, which summarises total earnings and tax paid. Employees should review their P60 carefully, as it helps confirm whether the correct amount of tax has been paid.
Employers may also issue P11Ds to report expenses and benefits. These documents ensure that additional benefits receive the correct tax treatment.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.