7.0 Introduction
The great thing about the modern
technological age is that 'the hard work' is often done for us, thus being time
efficient; especially in a large-scale business where there are so many staff
members, all with their own individual circumstances.
One person's tax code is totally
unique to another's, and you need to work out how much income tax they should
pay based on what they are allowed to earn without paying any tax.
Additionally, you need to work out National Insurance and also account for any
other deductions which need to be taken from their earnings.
Could you do all
this manually and with ease? No! Thankfully, software packages now do this for
us, and provided you choose an HMRC-recommended software package and explore
its functionalities and features first, you will not need to do much in the way
of manual calculations. Despite this fact, it is important to know about pay,
the different types, what they mean, and how to work them out in their most
basic forms.
This module will explore what gross pay
is, what net pay is, how to work it out if you need to (in a very basic form),
and more about software and how it can help you to run your payroll system
smoothly. We will also explore why a clear payslip is so important; to allow an
employee to understand their wages and deductions.
7.1 Gross Pay
Put simply, gross pay is the amount
of money an employee has earned before any deductions are made.
Gross pay has to appear on a payslip
in order to clearly show an employee how their final wages have been
calculated, to give transparency to the whole process and to keep everyone
aware of the financial side of their employment. Payslips need to show
deductions clearly in order to avoid confusion, which is where top-quality
software packages are very useful. We will discuss this in more detail later in
this module.
Gross pay is the amount which makes
up the yearly salary before deductions and is the contracted yearly salary for
that particular employee, divided by the number of months in the tax year.
7.2 Net Pay
Net pay is also
referred to as 'take-home pay' because this is the final amount an employee actually
receives each pay period.
Net pay is what is calculated after
all deductions have been made. Deductions can be for a whole myriad of things,
e.g. income tax, National Insurance, student loan repayments, private
healthcare contributions, union dues and pension contributions. There might
also be additions shown on the payslip, such as overtime worked or bonuses,
out-of-hours working supplements, or any allowances, such as petrol or uniform
payments. As you can see, every person's payroll record is totally different
and unique.
In its most basic form, a payslip
should show gross pay minus deductions, and any deduction should be itemised
with the amount, before arriving at the final amount, i.e. the net pay.
Deductions should be clearly identifiable e.g. income tax, National Insurance,
student loan repayment, pension contributions etc.
It is important that the employee
understands what deductions have been taken from their wages, as well as any
additions, which should be equally as clear for them to understand. If an
employee does not understand their payslip, it should be made clear to them
that they are able to seek clarification from their line manager. Put simply,
it is important that gross and net pay calculations are transparent.
7.3 How to Calculate Gross and Net
Pay Within Your Payroll System
Having a basic grasp of how gross and
net pay are worked out is important in order for you to understand how your
payroll system works overall.
In their most basic form, gross and
net pay are worked out as follows:
Gross pay
This is the yearly salary divided by
the 12 months in the year. To complicate matters a little, this is also
calculated on hours worked and the rate of pay per hour, including overtime. A
payslip needs to clearly show the hourly rate that particular employee is on,
to show transparency of this calculation. Employees may have a different hourly
rate if the organisation runs an incremental system.
Net pay
This is gross pay (calculated as
above), minus income tax, minus National Insurance, minus other pertinent
deductions, such as student loans, pensions, etc., plus bonuses or other
additions (after tax) = net pay. This is at its most basic form.
Each person who is employed in the UK
is allocated a tax code which details how much salary that particular
person is allowed to earn before they start paying any income tax. Everyone has
a tax-free allowance, so when working out net pay, income tax is only
calculated on the part of the salary which is taxable. Complicated? It
certainly can be! This is where your payroll software helps because by
inputting a tax code and the gross pay, as well as other deductions, the final
net pay will be worked out easily for you.
Tax codes are personal information
because it may be that an employee did not pay enough income tax the year
before and it is being recouped through their current tax year code, or they
are self-employed as well as being employed and paying income tax through PAYE,
with their self-assessment taxes also being collected through PAYE. This can
get complicated because peoples' circumstances vary and this is why top-quality
software is so important.
7.4 Payroll
Software
Top-quality
software is imperative for an accurate and smooth-running payroll system.
It doesn't matter whether you are
working for a large company or a small one, if you get the deductions wrong or
the net pay is wrong, you will find you have disgruntled employees and issues
too with HMRC. Putting right such calculation problems can be time-consuming,
yet is avoidable if you use the right payroll software from the start.
It
is important to shop around for your software package because it needs to
have all the features you require, without making the whole process
too complicated for your needs.
7.5 The Importance
of Having a Clear Payslip for Employees
Deductions taken from an employee's
gross pay can be variable from person to person and you will need a software
package which allows you to dedicate each pay record to a person's individual circumstances.
Having a package which produces
easy-to-understand payslips is just as important. Employees need to understand
why they have had certain deductions taken from their gross pay, resulting in
their final net pay figure which they take home with them at the end of the
week or month. The design needs to be easy to use, yet also support all the
needs of the business.
In the UK, payslips contain a lot of
abbreviations. Some important ones are explained below:
- BACS (Banker's Automated Clearing Services): This is a payment that
processes payments electronically.
- BA/BP (Bereavement Allowance/Payment): This is an allowance
given to surviving civil partners or widowers.
- CHB (Child Benefit): An allowance provided to parents with children
under 16 years of age (or under 20 if the child remains in approved
education of training as defined by Gov UK
- CHT (Child Tax Credits): Eligible only if an employee is already
receiving Working Tax Credit.
- ET (Earnings Threshold): The amount earned before you are
required to pay income tax.
- LEL (Lower Earnings Limit): The amount earned before you are
required to pay National Insurance.
- PILON (Payment In Lieu Of Notice): This refers to the
compensation received by an employee in lieu of the notice period in the
event of termination.
- PP (Pension Provider): Allowance given to a pension holder
- SMP (Statutory Maternity Pay): Pay of 39 weeks given to female
employees during the period of maternity leave.
- SPP (Statutory Paternity Pay): Pay of 2 weeks given to male employees
during the period of maternity leave.
- TY: Tax
year.
- Court Orders and Child Maintenance on Payslip:In some cases, the court may
order child maintenance or alimony to be directly deducted from the
employee's pay. Similarly, the court can also order debt or creditor
repayments to be directly debited from the salary. These will be shown
separately on your payslip.
- Work/Company Benefits: If you're availing of health insurance
or a company car, these will be listed separately on the payslip and may
also affect the tax code used.
A payslip should document the amount
of all deductions and additions, along with a description of what each relates
to. Any concerns regarding entries on a payslip should be communicated to a
manager, and that manager should have sufficient understanding to provide an
explanation to the employee. This is why training on the payroll system is
important at all levels. However, if there is ever any doubt a referral should
be made to the person(s) responsible for maintaining and running the payroll
7.6 Should You
Manually Check Your Payroll Figures
Smaller businesses
may occasionally need to manually check pay figures, and whilst these instances
will probably be few and far between, it's a good idea to know how to do this,
just in case the situation arises.
Sometimes figures might just not look
right and you may want to be sure before submitting your full payment
submission to HMRC. This is very sensible and something which you should always
look out for.
How
can you do this?
The HMRC website has manual online
calculators to help you check figures; however, the figures you receive from
these calculations should not be entered into your payroll software; you need
to adjust and look at the information your software has calculated, rather than
making changes. Payroll is not about guesswork - it needs to be accurate and
correct at all times.
If you are working within a small
business with relatively simple payroll deductions, you can do a quick
calculation yourself to see if you are within the right range. Again, do not
use these figures as your final submission. Calculated checks should probably
be left to dedicated software or online calculators such as on GOV UK
As a general guide:
· Start with gross pay: begin with the employee's gross pay, which
includes their regular salary, hourly wages, overtime, bonuses, and any other
additional earnings.
· Deduct income tax: use the tax code to determine the employee's tax-free
allowance. Calculate the taxable income by subtracting the tax-free allowance
from the gross pay. Apply the appropriate tax rates to the taxable income based
on the current tax bands.
·
Deduct National Insurance Contributions (NIC): calculate the employee's
NIC by applying the NIC rate to their gross pay.
·
Subtract additional deductions: depending on the employee's situation,
there may be additional deductions, such as pension contributions, student loan
repayments, or other deductions.
· Calculate net pay: after all the deductions are accounted for, subtract
the total deductions from the gross pay to determine the employee's net pay.
This is purely a guide only, which is why more in-depth calculation
software should always be your method of choice. There is no denying, however,
that manual checks are useful in some circumstances, especially for smaller
businesses with employees who have less complicated salary payments. Full
payment submissions to HMRC should always be through payroll software, which
has calculated deductions using more in-depth methods. Accuracy is key here.
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