Guide

What is PAYE?

The Pay As You Earn (PAYE) system lets employers forward Income Tax, National Insurance, and other payments to HMRC.

What is PAYE? And what does it mean for employers? If you have a team, or you’re thinking of hiring employees, understanding the PAYE system is essential for meeting your employer obligations.

Here, we share everything you need to know about setting up PAYE and explain how software can ease the administrative burden.

What is PAYE?

Pay As You Earn (PAYE) is the system HMRC uses to collect employee deductions for Income Tax, National Insurance, pensions, and other contributions. It’s widely used but can be complex.

As an employer, it’s your job to make these deductions on behalf of your employees and contractors and pass them on to HMRC. You can do this using payroll software.

You must register for PAYE with HMRC if you’re paying employees. And once registered, you’ll need to commit to the following tasks:

  1. Recording all money paid to employees and deducted from their earnings. These payroll records need to be accurate so the right deductions can be made.
  2. Keeping HMRC updated about your team, and letting them know about any changes in employment (employees joining or leaving the business) in a timely manner.

Of course, you’ll also need to pay HMRC the amounts deducted from employees’ pay.

When to register for PAYE

If any of the following criteria apply to your employees in the current tax year, you need to register for the PAYE system:

  • they’re paid at or above the lower earnings limit. For the 2024/25 tax year that’s £123 or more a week
  • they receive expenses and company benefits
  • they receive a pension
  • they’ve had another job
  • they’ve received Jobseeker’s Allowance, Employment and Support Allowance, or Incapacity Benefit

Make sure you’re registered for PAYE before the first payday – but no more than two months in advance of it.

You’ll be sent an employer reference number. This is a unique identifier that you’ll use to report to HMRC and communicate with them about your payroll. Receiving his number can take 30 days to arrive (so don’t leave registering until the last minute).

PAYE deadlines

You’re signed up for the system, but when does PAYE need to be paid? Some small businesses can forward employee deductions and payments quarterly, but most need to foot their PAYE bill monthly.

PAYE bills must be paid by the 22nd of the following tax month if you pay monthly. If you pay quarterly – this tends to be smaller businesses with smaller PAYE bills – you must pay after the end of the quarter. In practice that would mean your bill for the April to June quarter would be due on the 22 July.

Employers who expect to pay less than £1,500 can request quarterly PAYE deadlines. Contact HMRC’s PAYE helpline if you think that might be you.

PAYE deductions

PAYE deductions vary depending on the employee, their tax code, and other entitlements. But most employees will make contributions for Income Tax and National Insurance that you’ll need to forward. Other deductions like student loan repayments and attachment of earnings orders are also common under PAYE.

When processing payroll, you need to report your employee’s payments and deductions to HMRC on or before payday. These deductions are passed onto HMRC when you pay your PAYE bill. Payroll software will show you what Income Tax and National Insurance are owed.

You can also outsource PAYE to a payroll provider. But note: it’s your responsibility to get PAYE right for your business (even if you use a third-party service provider).

How to set up PAYE payroll

There are two steps for setting up PAYE. You’ll need to weigh up your online payroll software options, too.

1. Register as an employer with HMRC

The first thing you need to do is let HMRC know you’re hiring people. Head to the HMRC website and register as an employer. You’ll get a PAYE reference number, which you can use to access your online PAYE account. From here, you’ll be able to check what you owe HMRC, pay your bill, and receive notices from HMRC and more.

If you run a limited company, you should be able to register for PAYE online. Other business types may need to use a different method (you can find out more on the HMRC registration page). Make sure you allow 30 days to receive your PAYE reference number.

2. Choose a payroll software

Next, find payroll software to fit your business.

With HMRC-recognised payroll software in place, you don’t need to calculate deductions yourself – the software does this for you. Once you’ve set up pay rates and instructions in your payroll, sending reports to HMRC is simple. You can even produce PAYE payslips using the software, and distribute them to employees.

What does a PAYE payslip look like?

You need to give your employees their payslips on or before every payday.

Payslips will differ slightly, depending on what kind of contributions your employees make. But all should include:

  1. Gross wages (pay before deductions)
  2. Any deductions made (PAYE)
  3. Net wages (pay after PAYE and other deductions)
  4. Hours worked (if employee pay varies depending on hours worked)

You can also include things like your employees’ tax codes and National Insurance numbers, hours worked this year so far, and rates of pay. Modern payroll software generates payslips for you to email or print for employees.

How to pay HMRC through PAYE

Once you’ve made PAYE deductions on behalf of your employees, you need to submit these (along with your own employer contributions) to HMRC.

But working out what you owe takes multiple steps. Let’s look at how to calculate PAYE.

1. Deduct Income Tax

You’ll need your employees’ unique tax codes to calculate their Income Tax. Depending on their salaries, your employees may fall into different tax brackets (Examples: 20%, 40%, and 45%).

HMRC has a helpful PAYE tax calculator tool for doing the sums manually. Otherwise, modern payroll software will calculate Income Tax deductions for you.

2. Deduct National Insurance

To calculate National Insurance contributions, you need to determine your employees’ National Insurance class (which vary depending on age and employment status). You can find National Insurance classes and categories on the HMRC website.

3. Address student loans or other deductions

Some of your employees may be paying off their student loans, settling an attachment of earnings, or both. These payments need to be deducted from employees’ pay before they receive their monthly income.

When you take on a new employee, check with them to see if they have a student loan. You can record their answer in your payroll software, and their repayments will be worked out for you.

If you receive an earnings attachment order from the court for an employee, you can record this in your payroll software. Most softwares will help you manage priority and non-priority orders. You’ll also need to check if a priority court order is being deducted while an employee has student loan repayments, as its name implies these types of deductions take priority over the student loan deductions.

Check HMRC guidance on student loans and earnings attachments if you’re stuck.

4. Pension contributions

Even though pension contributions and deductions do not fall within the PAYE system, workplace pensions are a legal obligation that all employers need to comply with from the first day they employ someone. Pension contributions will depend on your scheme and the individual employee. Ensure these contributions are deducted and paid over to the scheme provider every pay period.

5. Handle statutory pay

Statutory pay, such as sick pay and maternity pay are treated as regular income for tax purposes. Make sure you record these in your cloud-based payroll software.

You’ll need to record dates across statutory pay types and ensure that the correct rates are applied to each statutory entitlement for your employees. Your payroll software will help you manage the dates, then calculate the right amounts for you according to the correct rate. You can use HMRC’s sick pay calculator if you’re doing the calculations manually.

6. Manage expenses and benefits

Expenses and benefits paid to employees need to be reported, this can either be payrolled and reported each time you pay employees or you can report these at the end of the year through annual P11Ds. If all of these expenses are accounted for in your payroll submissions, you don’t need to report them annually.

Check HMRC guidance on expenses and benefits to see what you need to pay.

7. Submit payments to HMRC

Monthly PAYE payments are due on the 22nd of the following month (if you pay online). For those paying by cheque via post, payments must reach HMRC by the 19th.

Interest and penalties apply for late payments, so make sure you pay your bill on time.

Along with the payments and deductions outlined above, your PAYE bill could include:

  • Employer National Insurance
  • Construction Industry Scheme (CIS) deductions
  • Apprenticeship Levy payments

Claiming PAYE tax refunds if you’ve overpaid your bill

There’s more than one way to claim a PAYE tax refund as an employer.

You can either use the overpaid tax as credit for future payments (deduct it from your next employer’s PAYE bill). Or, you can contact HMRC by post and request a refund – note, this can take months to process. So it might be easier to deduct the amount from your upcoming payment.

If the overpayment was due to an error, you must correct this in your next report to HMRC.

How payroll software can help with PAYE

Handling PAYE yourself can be time-consuming and complex. Cloud-based payroll software takes a load off – by handling deduction and payment calculations, producing HMRC-compliant reports, and ensuring the right money goes to the right places.

With Xero’s payroll software, you can navigate the PAYE system with ease. For more help with the business basics, check out our guides on how to start a business and how to do payroll.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

Start using Xero for free

Access Xero features for 30 days, then decide which plan best suits your business.

  • Included
    Safe and secure
  • Included
    Cancel any time
  • Included
    24/7 online support