PAYE is the common abbreviation for the Pay As You Earn
scheme that was first introduced by the UK in 1944 as a tax
system by the inland revenue which employers administer to
deduct from employees wages and salaries income tax and
national insurance contributions and account for the
employers national insurance contributions. Although
strictly speaking not part of the PAYE scheme employers
also use the pay as you earn framework and documents to
administer other deductions.
Every employer in the UK must register as an employer with
the tax authority. Register to administer a PAYE scheme is
obligatory if the employee has other paid employment or has
earnings at or above the PAYE threshold and liable for
deductions of income tax, or has earnings at or above the
national insurance lower earnings level. Registration can
take place up to four weeks before the first qualifying
employee is engaged.
The paye system is a scheme whereby employees are deducted
income tax and national insurance on a weekly or monthly
basis according to the frequency of wage and salary
payments by the employer who then pays the income tax and
national insurance contributions over to the inland revenue
in the UK each month.
The employer is also responsible for keeping a record of
the employers national insurance contributions which
together with the employee deductions are paid over to the
tax authority on or before the 19th of the month following
the pay period. Small business that has a quarterly
liability to income tax and national insurance less than
1,500 pounds per quarter can arrange to pay the PAYE every
three months rather than every month.
PAYE administration involves the calculation of income tax
using a tax code system. Each employee is allocated a tax
code which consists of a number equal to approximately one
tenth of the personal tax allowance as adjusted by the
employee personal tax adjustments. Special conditions and
circumstances for each employee is usually representing in
the tax code with a letter known as a suffix to the prefix
tax code number.
The financial tax year in the UK is from 6 April one year
to 5 April the following year with each tax year divided
into 53 specific week numbers that accounts for days over
at the end of the year and also into 12 monthly periods.
Income tax deducted is calculated by the employer operating
the PAYE scheme on a cumulative basis during the tax year
by using either manual tax tables or a payroll software
package. The tax table is arranged to determine the tax
free allowance each pay week or month during the year
according to the employee tax code.
To calculate the income tax the employer determines the
cumulative tax free allowance in a specific week or month
and deducts this allowance from the cumulative gross pay
that employee is due at that tax week including current
wages or salary and all previous income earned during the
current tax year including any earnings from other
employers. Having established the taxable pay that amount
is then applied to the percentage of income tax to be paid
under the current tax rules for that financial year.
The employer is responsible for deducting the correct
amount of income tax, issuing the employee a payslip to
advise the income tax deducted and also for paying the
income tax deducted to the tax authority. The PAYE
calculations and production of payslips is an essential
function of payroll software that many employers adopt to
ensure accuracy and compliance with the regulatory bodies
tax rules.
The second major area of PAYE administration is for
employees to deduct national insurance contributions from
employees. National insurance contributions are calculated
not on a cumulative basis as income tax but are calculated
according to the gross income earned in a specific pay
period based upon the gross pay during that weekly or
monthly pay period.
The amount of national insurance deducted is determined by
looking up the employee gross pay on a national insurance
deductions table. A different national insurance table is
applied according to the personal circumstances of the
employee. In addition to the employee national insurance
contribution each employer also has to pay an employer
national insurance contribution.
PAYE administration is a series of payroll and deductions
documentation related to the payment of wages and salaries
to employees. The majority of businesses use payroll
software to automate the calculations and produce the
information required for the PAYE returns.
The starting point of the PAYE system is the P45 which all
employees receive when they leave an employment and is a
certificate of the cumulative gross pay and income tax
deducted up to the date of the P45. Details from the P45
also include the employee tax code that must be entered
into the employee PAYE records to enable the new employer
to calculate the income tax due to date.
If an employee does not hand the new employer a P45 then
they are taxed on a week to week basis until the tax code
and cumulative income tax position are known. Confirmation
of an employee tax position is obtained by the new employer
by submitting a P46 form to the Inland Revenue when an
employee does not have a P45.
Having engaged an employee and deducted income tax and
national insurance contributions the employee must receive
a payslip from the employer showing the gross pay,
deductions and net pay. In additional the employer also
needs to maintain records of payments to the employee and
deductions made. Payroll software can produce these records
and the Inland Revenue also provide small employers with a
P11 deductions working paper for this purpose.
At the end of the financial tax year for payroll three main
PAYE documents are required to be completed by each
employer. Each employee has to be given a P60 certificate
of earnings and deductions during the financial year. The
P60 is an important document and often required for many
diverse purposes unconnected with the PAYE system such as
future mortgage applications and other purposes as proof of
income.
The employer also has to complete a P14 for each employee
which is the form on which the employee deductions and
statutory payments are recorded. The P14 is sent to the
Inland Revenue.
In addition every employer also has to complete a P35 which
is the Annual Employers Return which lists the name of
every employee, the income tax deducted and national
insurance liability including employee and employer
contributions. The P35 also includes statutory payments
made to employees and the amount of the employer has
already paid to the Inland Revenue. In the UK employers can
receive a tax free bonus for filing the P35 details online.
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Terry Cartwright, CEO at DIY Accounting, designs Accounting
Software for small to medium sized businesses
http://www.diyaccounting.co.uk/ and Paye Payroll Software
packages for up to 20 employees at
http://www.diyaccounting.co.uk/payroll.htm
