PAYE Tax – a guide for small businesses

With the Pay As You Earn (PAYE) system, employers deduct tax and national insurance (NICs) from their employees’ earnings including statutory pay which is then paid to HMRC, known as PAYE tax.

Most UK employers use a PAYE payroll system to accurately work out how much income tax and NICs their employees owe and then deduct this from their wages before they are paid. Deductions are determined by an employee’s tax code and their National Insurance category letter, as well as pension contributions, student loan repayments and – in some cases – child maintenance payments.

There’s no need to register for PAYE if none of your employees are paid £118 or more a week, just get expenses and benefits, have another job or get a pension. However, you must keep payroll records.

Failing to pay the correct PAYE tax to HMRC when required can lead to interest and penalty payments. Employers are legally responsible for completing all PAYE tasks, even if they outsource them. Understanding payroll and PAYE tax is important for any small business owner to ensure you avoid penalties and staff are paid accurately and on time.

Setting up your PAYE payroll

If you’re starting up and haven’t employed an accountant to take care of your payroll, you can set up a payroll system yourself. But before you can do this, you’ll must:

  • Register as an employer with HMRC. This so you can get your employer PAYE reference number and be able to login to use PAYE Online. Even if you’re the only employee of your business or the sole director of a limited company you must register.
     
  • Choose your payroll software. The software must be able to report PAYE information in real time to HMRC.
     
  • Record all sums paid to your employees. This needs to include deductions taken from their earnings, and you’ll need to report these sums to HMRC before payday and then pay Income Tax and NICs payable to HMRC.
     
  • Maintain accurate payroll and PAYE tax records. You must also tell HMRC about relevant changes regarding your employees.

Employee PAYE payslips

You must give your employees a payslip on or before payday. It should detail their gross wages (earnings before deductions), deductions, net wage or take-home pay, hours worked and rate of pay, their National Insurance number and tax code as well as the earnings and deductions taken so far within the current tax year. Payroll software produces a payslip for each employee, which you can print and give to them or simply email it to them.

How PAYE tax works

Most employers use payroll software, which makes calculating pay and deductions easier and quicker. For PAYE tax purposes, pay can also include tips, benefits, bonuses, commission and statutory maternity or sick pay.

Employee payments and deductions must be reported to HMRC just before or on payday. Commercial payroll software can report PAYE information to HMRC online in real time.

Employers must tell HMRC if they take on a new staff member. They must also let HMRC know if an existing employee’s circumstances change, for example, if they reach state pension age or become a director.

PAYE forms – P11D, P11D(b), P60 and P45

At the end of the tax year which ends on April 5, employers must submit a P11D form to HMRC for employees who have received expenses or benefits.

You also need to submit a P11D(b) form if you’ve previously submitted any P11D forms; you’ve paid employees’ expenses or benefits through your payroll or if requested by HMRC. From this, HMRC can work out how much Class 1A NICs your business must pay on taxable expenses and benefits.

You must also give your employees a P60 at the end of the tax year. This is a statement summarising their pay and deductions for that tax year. You must give your employees a P45 when they leave your employment.

Paying PAYE deductions to HMRC

Based on the data you input, your payroll software will tell you how much PAYE tax you need to pay HMRC. This is usually payable each month, however small businesses that expect to pay less than £1,500 a month can arrange to pay quarterly. If your business qualifies, you can contact the HMRC payment enquiry helpline on 0300 200 3401 to discuss this. The helpline is open Monday to Friday between 8am and 8pm, and on Saturday between 8am and 4pm.

Employers use the HMRC PAYE Online service to access tax codes and notices about their employees, as well as receive alerts from HMRC when reports or payments are late or appeal any penalties.

You use payroll software to send a Full Payment Submission (FPS) to report to HMRC payments made to your employees and deductions taken from their earnings. To do this, you’ll need to enter your PAYE reference and Accounts Office reference into your payroll software – you get both reference numbers when you first register as an employer.

The FPS must be sent either on or shortly before payday, even if you pay HMRC each quarter (rather than monthly). There are circumstances when sending an FPS after payday is allowed. Your payroll software should provide instructions on how to complete and send your FPS.

Ways to pay HMRC

Same or next day payments can be made to HMRC using online or telephone banking or CHAPS using the PAYE HMRC account details for payments. Allow three working days to pay by either debit or company credit card online; BACS; at your bank or building society by cash or cheque; Direct Debit; or by cheque via the post.

To verify that HMRC has received your payment, you can check your HMRC online account. The payment should show within six working days.

Key PAYE tax deadlines

  • In the next tax month, you can access your HMRC online account from the 12th day of the month to see your FPS and find out how much in tax and NICs your business owes.
     
  • By the 22nd day of each month, you must pay HMRC deductions taken from your employees’ earnings in the previous month as reported on your FPS.

The Government provides more in-depth payroll and PAYE guidance for employers on managing your payroll obligations.

PAYE tax refunds

You can claim a reduction on the money you owe to HMRC by sending an Employer Payment Summary (EPS) by the 19th day of the month, with the balance paid on the 22nd day, or the 19th day if you’re paying by post. Overpaid tax is used as credit against future payments, or you can apply for a PAYE tax refund at the end of the tax year. Overpaid tax should be refunded through payroll to the respective employee if, for example, a payroll mistake was made and too much income tax paid.

PAYE tax codes

To find out how much tax to deduct from an employee’s pay, you can enter their tax code into your payroll software. A new employee’s tax code can be found on their P45, which they must receive when they leave their former employer.

An employee’s PAYE tax code is made up of a number and a letter or letters. Once multiplied by 10, the number shows how much tax-free income they can earn during that tax year. The most common tax code for tax year 2019-2020 is 1250L. It applies to people with one job and no untaxed income, unpaid tax or taxable benefits such as a company car.

The letters in an employee’s tax code refers to their employment/tax circumstances and how this affects their Personal Allowance , such as how much someone can earn in a year before tax is payable.

You may need to update your employee’s tax code at the start of a new tax year, because the number can change. If the tax code changes during the year, HMRC will let you know. Then you can update your payroll records to ensure the correct amount of tax is deducted.

PAYE tax tips

  1. If you’ve ten employees or less, use free payroll software that is HMRC approved. It must be able to report PAYE information to HMRC online in real time. HMRC has a list of free payroll software to choose from.
  2. If you’ve ten or more employees, you can use paid-for software that enables your business to report in real time. HMRC has a list of paid-for payroll software to choose from.
  3. The payroll software you choose should give you the full range of capabilities your business needs. For example, you may need it to produce payslips or make pension payments.
  4. When completing your Full Payment Submission (FPS) to report payments and deductions to HMRC, split staff into groups to make the task more manageable. For example, do employees first, then directors, or full-time staff first, then part-timers.
  5. If you’ve made a mistake in your FPS, correct it as soon as possible.
  6. Check if you need to deduct child maintenance directly from an employee’s earnings or pension.
  7. You’ll need to ask HMRC for a payment booklet if you want to pay PAYE tax at your bank/building society or by post.
  8. You must inform HMRC if you haven’t paid any employees for at least one tax month. You do this by filling in an Employer Payment Summary (EPS), which must be sent by the 19th day of the month following the tax month when no employees were paid. Failure to do so can lead HMRC to send you a notice estimating how much you owe, while you may also have to pay a penalty.
  9. If your payroll software does not produce P60s, you can order copies from HMRC.
  10. Make sure you update your payroll software so that it uses the latest rates and thresholds.
  11. If your business does not maintain full PAYE/payroll records, HMRC may estimate how much is payable – and hit you with a penalty of up to £3,000.

Feeling Inspired?

Register
Start Up Loans uses cookies on this website. Please visit our Cookie Policy to find out more or if you're happy to receive all cookies, please continue browsing.