PAYE, or Pay As You Earn, is a form of income tax that employees are obligated to pay, either through direct deductions from their salaries or wages. This mechanism serves as the HMRC's means of collecting taxes from the workforce.

As an employer, it falls upon you to ensure that your organization's PAYE system functions systematically and that employees contribute their fair share of taxes to the government.

In this article, we will delve into the intricacies of PAYE, its operational principles, and the method for calculating it. Let's commence by revisiting the fundamentals of PAYE.

Understanding PAYE

In essence, PAYE serves as a tax collection system designed to guarantee the government's revenue generation from its citizens. It involves the direct deduction of income tax and national insurance contributions from each employee's monthly earnings, with these deductions being remitted to HMRC on a monthly basis. Comprehending the concept of PAYE and how it functions is vital for employers and employees alike.

Calculating PAYE

The amount an employee owes in PAYE is contingent on their income. To illustrate how PAYE is calculated for employees, consider the following example:

For the 2021-22 tax year, the tax-free personal allowance stands at £12,570 annually. Beyond this allowance, various tax rates apply, depending on the individual's income bracket. Here is a reference table:

Now, let's examine the employer's responsibilities in paying employees:

1. Statutory payments, including sick pay, maternity pay, and adoption pay, may need to be made.
2. Certain expenses and benefits, such as uniforms and company vehicle policies, must be reported separately at the end of the fiscal year.
3. Bonuses, incentives, holiday pay, medical suspension pay, cash prizes, and similar payments are categorized as regular income. However, exceptions may apply when customers directly provide tips or commissions to employees.
4. Deductions, including student loan repayments, pension contributions, payroll giving, and childcare costs, should be considered in the PAYE calculation.

How PAYE Operates

The tax year for 2021 spans from April 6, 2021, to April 5, 2022. Employers must identify their employees' taxable income, deduct the relevant allowances to arrive at the taxable amount, and place each employee in the appropriate tax bracket. Finally, the PAYE amount must be remitted to HMRC.

To fully grasp the PAYE concept, employers should also have a sound understanding of NIC (National Insurance Contributions).

NIC refers to an employee's contributions to the National Insurance Fund, which is a type of tax deducted from their earnings. Employees derive various benefits from these contributions.

National Insurance Under PAYE

Employers play a pivotal role in collecting and remitting NIC payments to HMRC. These contributions are based on individuals' earnings as a percentage. Generally, both employees and employers make contributions. Employers make secondary class 1 contributions, while employees contribute primary class 1 contributions.

For the 2021-22 tax year, employees are not required to pay NIC contributions on earnings up to £797 per month. Any earnings exceeding this threshold are subject to taxation. Employers, on the other hand, must pay NIC on employees' earnings exceeding £737 per month.

It is natural to find these aspects confusing, but as an employer, reporting NIC contributions is an essential responsibility. Maintaining comprehensive records under the PAYE system is the most effective approach.

It is crucial to differentiate between NIC and tax. While tax can be calculated cumulatively, NIC calculations depend on an employee's earnings, which can be weekly, monthly, bi-weekly, or specific to their payday.

Employer's Responsibilities in Summary

If the intricacies of PAYE appear overwhelming, consider these concise points to understand your responsibilities as an employer under the PAYE system:

1. Adhere to PAYE guidelines and ensure accurate deductions and calculations.
2. Maintain records for each employee, including their deductions.
3. Document employee-specific benefits and perks.
4. Submit all payment and deduction-related details to HMRC.
5. Keep a record of both your and your employees' National Insurance Contributions.
6. Provide payslips to employees, enabling them to track their financial records effectively.