What is PAYE?

How does PAYE work?

The employer registers with HMRC as an employer and gets a PAYE reference. Each pay day, payroll software works out gross pay, then the income tax and National Insurance due using the employee's tax code and HMRC's current tables, and deducts them. The employee receives the net amount and a payslip; the employer receives a bill.

On or before each pay day the employer sends HMRC a Full Payment Submission under Real Time Information, listing every employee, what they were paid and what was deducted. The deductions, plus the employer's own National Insurance on top, are paid to HMRC monthly: by the 22nd if paying electronically, which almost everyone does.

PAYE also carries other things that ride along with pay: student loan repayments, pension contributions under auto-enrolment, statutory sick and parental pay, and the cumulative tax adjustments that stop people over- or under-paying across the year. The employer is doing HMRC's collection for it, and is liable if it goes wrong.

A worked example

A bakery takes on its first employee at £2,000 a month gross. Payroll software applies her tax code and the current rates and, for illustration, arrives at £190 of income tax and £90 of employee National Insurance. Her payslip shows £2,000 gross, £280 of deductions and £1,720 net, which the bakery pays to her bank.

The bakery also owes employer's National Insurance on her pay, say £150 for the month. Its total cost of employing her is therefore £2,150, not £2,000, and the amount due to HMRC by the 22nd of the following month is £190 plus £90 plus £150, so £430.

The figures for tax and National Insurance change at Budgets and depend on the tax code, so treat the numbers above as the shape of the calculation rather than a forecast. Payroll software uses the live rates; the bakery does not need to know them, only to pay what the software says by the date it says.

PAYE or Self Assessment?