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Pay As You Earn or PAYE is the system currently used by HM Revenue and Customs (HMRC) to collect both National Insurance Contributions and Income Tax from the wages and occupational pensions of employee’s.
PAYE - A brief history
Tax systems have been dated back to the earliest recorded history, with the ancient Egyptians, Greeks and Romans all operating basic tax collection systems in order to fund certain public services. Though taxation today is far more complex, the basic premise of collecting money in order to pay for shared services remains the cornerstone for most systems.
Income Tax is currently the main system of collecting money from the public in order to pay for public services. This tax was first implemented in 1799 as a means of funding the war effort against the French forces under Napoleon, after which the government continued to use levying taxes as a way to fund any civil conflicts.
This system worked relatively effectively up until World War I, when the enormous cost of the war left the country in a staggering amount of debt, prompting the government to consider a new approach to tax collection.
Up until this point in history, taxpayers had always been expected to make two bi-annual tax payments to the government independently. However, the debt crisis caused by World War I and the financial strain placed upon the country by World War II meant that the Treasury needed to collect more tax from more people and thus the Pay As You Earn system was developed.
The PAYE system was developed by Sir Paul Chambers and introduced into the UK in 1944 in a bid to cope with the ever increasing number of employers and employee’s who has previously not come into contact with the tax system.
Instead of the two yearly tax payments, the PAYE system required employers to automatically deduct tax on a regular basis from their employee’s wages, as well as providing them with a P45, a document which records personal information which is to be passed on to any new employers.
Now, operating the PAYE system is a legal requirement for anyone making payments to employees or members of occupational pension schemes, meaning that employers are responsible for deducting both Income Tax and National Insurance from any payments made to employee’s (before they receive them), the total sum of which is sent off to HM Revenue and Customs (HMRC).
As an employer it is your responsibility to ensure these deductions are made before paying your employee’s their wages or pensions. Below you can find a brief summary of both National Insurance and Income tax, and why they are necessary:
Anyone who is aged 16 or over who is an employee or who is self-employed must pay National Insurance contributions if their earnings are above a certain amount. National Insurance payments are essentially your contribution towards state benefits - including your state pension, and they also go towards the costs of the National Health Service.
Income tax is taken from earnings from employment, savings interest, investment income and certain benefits, and is the government’s way of raising money to spend on public services.
What is my responsibility as an employer?
As mentioned above, employers are legally obliged to operate PAYE on the payments they make to any of their employee’s, if their earnings reach what is known as the National Insurance Lower Earnings Limit. This limit is put in place by the government and is subject to change at the beginning of each tax year.
Employers will need to obtain the National Insurance category letter for each employee in order to work out how much Income Tax and National Insurance they need to deduct from their wages.
The PAYE system must be applied across all payments that employers make to employees, including the following:
- salary and wages
- tips (unless they are paid directly to the employee or pooled and then shared between employee’s – this is known as a tronc.)
- statutory payments - Statutory Sick Pay, Statutory Maternity, Paternity or Adoption Pay
- redundancy payments
- premium bonds.
As well as deducting Income Tax and National Insurance Contributions, employers may also have to make additional deductions such as for student loan repayments and pension contributions.
Employers are required to provide their employee’s with a statement of their pay either before they pay them or at the time of payment. Depending on the company and payroll system, this may be issued in either paper or electronic format but either way it must include the following information:
- gross pay before any deductions
- details of all deductions and the purposes for which they are made
- net pay/take home pay, after all deductions have been made.
Employee’s who are not issued with an itemised payslip are well within their rights to complain and to take their company to an employment tribunal.
At the end of each tax year, employers must issue any employee who has worked within their company since the beginning of that tax year (currently the 5th of April) and who has earnings above the National Insurance Lower Earnings Limit with a summary of their pay and deductions (otherwise known as a P60).
Real Time Information (RTI)
Real Time Information is legislation introduced by HMRC (in April 2013) to improve the operation of PAYE. While RTI has not changed the way employers need to calculate PAYE, it does mean that PAYE information will need to be submitted to HMRC every time employees are paid, as opposed to just once a year at Payroll Year End.
To comply with legislation, businesses who run their own payroll must ensure they are using RTI-enabled payroll software.
If on the other hand, payroll is outsourced to an accountant, very little will change as they will take care of most of the behind the scenes business for you. As a responsible employer however, it is always advisable to make yourself aware of any legislation changes and how they may impact your business, if at all.
How could an accountant help me to operate under the PAYE system?
Operating under the PAYE system can be both time consuming and confusing, especially if your business does not have a dedicated payroll department or specialist. Though initially contracting an accountant will increase your overheads, in the long run it could help to both free up time and money as well as having the additional benefit of giving you peace of mind that someone with ample knowledge and experience will be taking on the responsibility.
Accountants and firms who offer payroll services will usually provide the following services:
- If you are a new business an accountant can register you as an Employer with HMRC and can calculate you payroll using accredited software.
- Payslips for your employee’s.
- Submit RTI returns.
- Advice on how much to pay HMRC.
- P45s if an employee leaves.
- End of year tax return.
- P60s for employees when the tax year ends.
- HM Revenue and Customs – PAYE for employers: the basics
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