PAYE - The Basics

PAYE (Pay As You Earn) is the system that HM Revenue & Customs (HMRC) uses to collect Income Tax and National Insurance contributions (NICs) from employees' pay as they earn it. The term 'employee' in this guide includes directors of limited companies.

As an employer, you'll have to deduct tax and NICs from your employees' pay each pay period and pay Employer's Class 1 NICs if they earn above a certain threshold. You pay these amounts to HMRC monthly or quarterly. If you don't send the correct amount, or if you send it in late, you may have to pay interest. After the end of the tax year you must send HMRC an Employer Annual Return (form P35 and forms P14). Almost all employers are required to send this online.

Employers' responsibility for PAYE

As an employer you have a legal obligation to operate PAYE on the payments you make to your employees if their earnings reach the National Insurance Lower Earnings Limit (LEL). For the tax year 2010-11 this is 97 a week, 421 a month or 5,044 a year.

You use the employee's tax code and National Insurance category letter to work out how much Income Tax and NICs to deduct from their pay and how much Employer's Class 1 NICs you owe on their earnings. By the 19th of each month - or by the 22nd if you make electronic payments - HMRC must have received the amounts owed. You may be able to send the amounts due every quarter if your average monthly payments are likely to be less than 1,500.

What payments does PAYE apply to?

PAYE is applied to all the payments that an employee receives as a result of working for you, including:

  • Salary and wages
  • Overtime, shift pay and tips - unless these are paid directly to your employee or they come out of an independent tronc
  • Bonuses and commission
  • Certain expenses allowances paid in cash
  • Statutory sick pay
  • Statutory maternity, paternity or adoption pay
  • Lump sum and compensation payments - like redundancy payments - unless they're exempt from tax
  • Non-cash items like vouchers, shares or premium bonds - you apply paye to the cash value of items like this

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