PAYE (Pay As You Earn) is the system used by employers to handle tax and National Insurance contributions due on employees’ pay. Detailed PAYE tax calculations and processes can be complex, but payroll services or software can make things much easier for you.
You are legally obliged to operate PAYE for any employee with an income above the lower earnings limit (£112 per week, £486 per month in 2015-16) based on what the employee earns and their personal allowances. Company directors, high earners and employees with complex tax affairs will also need to complete their own self-assessment tax return at the end of the year to work out how much tax is due.
PAYE is also used to deduct employee National Insurance contributions. The employee’s deductions, together with the employer’s National Insurance contributions, are then paid over to HM Revenue & Customs (HMRC).
Statutory payments (such as statutory maternity pay) and deductions such as student loan repayments are also handled through PAYE. Tax and National Insurance on employee benefits are also dealt with using PAYE — either as part of the regular payroll or at the end of the tax year.
A new way of reporting PAYE called Real Time Information (RTI) was introduced by HMRC in 2013. According to HMRC (Gov.uk), the changes were introduced because: “When PAYE was introduced almost 70 years ago, most people held just one job for life and employers sent us pay and tax information annually.
"Many people [now] change jobs more frequently, or have multiple employments or pensions, making it more difficult for us to keep our data up-to-date. We also need up-to-date information about employment and pension income so the Department for Work and Pensions can adjust claimants’ Universal Credits.”
Following the changes, by law, employers must now submit information about all PAYE payments to HMRC online every time a payment is made as part of their payroll, whether weekly or monthly, rather than at the end of the year, as was previously the case.
If you take on staff, you'll need to set up and operate a PAYE scheme and register as an employer with HMRC. Visit the HMRC website to read Taking on a new employee - first steps for detailed guidance. You also need to decide how you want to manage your PAYE obligations. You can deal with PAYE yourself using HMRC’s own basic tools and calculators to deal with the key PAYE forms and report your PAYE information to HMRC, but this can be complex and time-consuming. Bear in mind that HMRC software will not handle pension contributions and other deductions or produce payslips.
RTI compatible commercial payroll software offers a more complete solution that is easier to integrate with your other systems. Compatible payroll software will include a PAYE calculator that works out deductions and will automatically complete PAYE forms and information for you.
Alternatively, you may want to outsource PAYE to a payroll service provider (your accountant may offer this).
The new RTI PAYE system is also linked to benefit payments (Universal Credit). So, it really is worth discussing how you plan to handle PAYE with your accountant.
PAYE tax calculators use the individual’s PAYE tax code to work out how much tax-free pay is allowed in the year and how the income is to be taxed. Different letters indicate which allowances the code is based on and whether special tax treatment applies. For example, the emergency code for 2015-16 is 1060L.
To use a PAYE calculator to work out National Insurance contributions, you also need to know the employee’s National Insurance category letter. This is because different National Insurance rates apply, depending on whether the employee is a member of a contracted-out pension scheme and other factors.