The PAYE system is a payroll administration system whereby employers deduct on a weekly or monthly basis income tax and national insurance contributions from employees wages and salaries. The PAYE administration involves the calculation of deductions, often performed by payroll software, and the payroll tax returns and forms required by the tax authority which in the UK is the Inland Revenue.
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 personal 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 wage or salary that employee is due at that tax week including both 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 wage slip 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 tax form 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 Pay As You Earn 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.