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What is PAYE and Why Does My Company Need It?

If you’ve ever been employed, you’ve probably heard the term Pay As You Earn, or PAYE, before. It should pop up every time you get your wages! The PAYE system has been around since 1944, and it plays an important part in financial regulations. It’s required by both employees and employers!

So, what is PAYE and why might your company need it?

What is PAYE?

As mentioned above, PAYE stands for Pay As You Earn. It is essentially an automatic taxation system and is the primary way employees pay income tax on their salaries. Before your salary reaches your bank account, PAYE deducts income tax (in the same way as National Insurance Contributions and student loan repayments are deducted) and sends it to HMRC. Once these deductions are made, your wages are then ready to be transferred to your account.

If you’re self-employed, you won’t have to worry about PAYE. Instead, you’ll need to fill out and submit a Self Assessment tax return. If, on the other hand, you’re an employer, you’ll need to set up and register for the PAYE system for your employees.

person organizing files
PAYE is an automatic system for the employed – the self-employed, on the other hand, must fill out a Self Assessment Tax Return.

How much does HMRC deduct through PAYE?

Your income tax contributions are primarily based on two things. Firstly, how much you earn and, secondly, whether you’re eligible for the full personal allowance amount. The personal allowance refers to the the first £12,570 (as of 2021/22) of your salary – if you’re eligible, this amount is protected from tax deductions. For each amount over the personal allowance, you’ll be charged a certain rate depending on the threshold your salary falls in. These charges will usually be split into equal payments throughout the year. On some occasions, it may occur that you’ve paid too tax. If this happens, you’ll receive a refund from HMRC or, if you’ve paid too little tax, you’ll receive a bill asking you to pay the amount due.

For those earning more than the personal allowance, £12,570, but less than the threshold value for the Higher-rate tax, £50,271, you’ll be charged at a rate of 20% on all income above the personal allowance.

For those within the Higher-rate threshold – earnings between £50,271 and £150,000 – you’ll pay a 40% tax rate on your income.

For those of you lucky enough to be earning £150,001 or more, your earnings will be taxed at the Additional-rate of 45%.

It should also be noted that for every £2 you earn over £100,000, your personal allowance will reduce by £1!

cash and credit card
Tax is deducted at different rates depending on your income!

Setting up PAYE as an employer

If your business has grown to the point where you hire staff, you’ll need to set up payroll to manage and distribute salaries. The primary purpose of payroll is to operate the PAYE system. Payroll simply monitors the total salaries you pay to your employees and, as a result, the amount of money each individual owes to HMRC through PAYE.

So, when you set up payroll, you’ll also automatically set up the PAYE system!

Here’s the six step process on how to set up payroll outlined on the government website:

  • Register – Your first step is pretty simple! You’ll need to notify HMRC that you’re an employer – you won’t need to set up PAYE if you don’t have any employees! When you register as an employer, you’ll receive a login for PAYE’s online system.
  • Choose – After you’ve registered for the PAYE online system, you’ll need to choose a payroll software. This payroll software will help you record employee details, calculate their pay and any necessary deductions, as well as report this information to HMRC.
  • Keep – You’ll need to keep and collect records of your this information, particularly your employee’s pay and deductions. You should also collect records of the reports and payments you make to HMRC as well as other details.
  • Inform – Your next obligation is to inform HMRC of your employees. This must be done before they are paid and involves a five-step process – a detailed account of these steps is available on the government website. In short, you need to check whether you need to pay this employee through PAYE and receive enough information to determine their tax code. You also need to know if they’re obligated to repay a student loan. You should use this information to set up your employee in your payroll software and, finally, register the employee with HMRC using a Full Payment Submission (FPS).
  • Payday – On or before the first payday, you will be required to record the employees pay for that period, make the necessary deductions and report these deductions to HMRC.
  • Pay – The final step is simple – pay HMRC the tax and national insurance you owe based on the deductions made at the previous step!

You might not think setting up payroll and using the PAYE system is important; however, it’s a legal requirement and helps maintain the proper payment of tax, National Insurance Contributions and student loan repayments!

Your requirements as an employer are more than those of your employee. As it’s an automated system, employees don’t really need to do anything when it comes to paying tax – although it’s handy if you know your tax code! Employers, on the other hand, have a responsibility to set-up payroll and keep records of contributions, wages and reports.

The Bottom Line

PAYE is one of the most important ways our government regulates the financial contributions made by employees into the societal system. Without PAYE, we might not be able to have our NHS or any other public service funded by taxpayers!

Whilst the system is fairly easy on employees – given that you don’t really have to do anything! – it is a little harder on employers. It requires a lot of financial administration, record-keeping and, most importantly, it can eat up a lot of time! And, given that you likely didn’t start your business with this financial documentation in mind, it can take you away from doing what you love.

That’s why a service like ours exists. We created our business to deal with all these messy financial details on your behalf, saving you time, energy and even your bank balance! So, if you’re ready to outsource your financial management, or you just need help setting up payroll, get in touch with our specialists today!

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