13.1 Introduction
In order to make paying taxes and
National Insurance easier, HMRC introduced the PAYE system, which stands for
Pay As You Earn.
It is how an employee pays their
income tax and National Insurance contributions as they earn their wages.
We have mentioned PAYE in passing in
previous modules, but in this module, we will explore this in more detail;
including how you report deductions through PAYE to HMRC and what your software
should include to enable this to happen. We will also explore tax codes in
greater detail and explain why they are important. PAYE is designed to make
paying deductions to HMRC much easier and provided you understand the system
and how to report deductions, it works very well indeed.
What is the PAYE system in the UK?
The PAYE system in the UK was
introduced in 1944 as a system to cope with an increasing number of taxpayers.
Instead of the previous method of paying taxes on an annual basis, the new PAYE
system was introduced to be able to tax more regularly, efficiently and easily.
It's extremely important to keep
payroll processes reliable and punctual. Delayed or inaccurate salaries can
affect the morale of workers and ultimately affect productivity. While prompt,
timely and accurate salary disbursals are necessary, it's equally important to
comply with payroll rules, laws and regulations. Today, the PAYE system is a
technologically robust system that has made tax calculations and payments to
HMRC easy and convenient.
PAYE was fully computerised in 1984.
With the implementation of the EDI
(Electronic Data Interface) employers found that they were able to pay taxes
and NIC dues within minutes. Most importantly, PAYE has revolutionised the role
of employers and has enabled them to make tax payments easily and quickly.
Moreover, employees are able to move between jobs without any confusion
regarding tax payments. Overall, PAYE is a core function of any business and no
organisation in the UK that hires staff can function without it.
A payslip is given to an employee
every time they are paid, which details how much income tax and National
Insurance was sent to HMRC via the PAYE system; thus allowing everyone to stay
up to date on what is happening in relation to deductions.
As an employer, you will be
instructed by HMRC on how much income tax and National Insurance your employees
need to pay, via their tax code. We will discuss tax codes in greater detail
later in this module: what they mean, how they are made up and what they stand
for. It is important to have a very good understanding of tax codes; however,
for now, we will simply state that the tax code will tell you how much to take
from an employee's gross pay, and this will be calculated by your payroll
software after inputting the tax code at the start of their employment. Tax
codes can change, so staying up to date with changes and inputting these
correctly into your software is imperative in order to avoid calculation
issues.
The PAYE system is reported in
real-time, which is referred to in a more technical manner by the abbreviation
RTI. This is a part of all HMRC-recommended payroll software and it allows
correct and up-to-date information to be reported to HMRC. This ensures the
correct deductions are made and is designed to avoid adjustments due to overpayment
or underpayment. We will discuss software in relation to PAYE a little later in
this module.
Having contributions taken from wages
means that there are no discrepancies, provided the employer deducts the
correct amount of tax and National Insurance from an employee's gross pay.
Generally speaking, unless there is a problem with the tax code, e.g. an
emergency tax code in place, then it is unlikely that there will be an under or
overpayment.
At the end of the year, HMRC reviews
the total tax amount paid by each person. In the event of underpayment or
overpayment of taxes, HMRC
will send a P800 form for tax calculation. If an employee has
overpaid tax, HMRC will issue them with a refund. If they have underpaid tax,
they will have to repay the difference to HMRC.
13.2 PAYE System
Benefits for Both Employers and Employees
Tax has to be paid
by the employee and when it is done this way, it is much less of a problem overall;
ensuring correct payment to HMRC.
In terms of employers, the PAYE
system makes deductions easy. Software does the hard work for you and you
simply need to ensure that you keep an employee's payroll record up to date
from the very start. If there are any changes in circumstance, you need to
action these immediately and report them to HMRC, in case this affects their
tax code. The tax code tells you how much to deduct, so if this is incorrect,
you are going to be taking an incorrect amount of money from your employee's
wage. PAYE is an easy-to-use system; the general ethos of the system is easy to
understand overall.
13.3 Tax Codes and
Their Importance
In this section, we
will explain what tax codes are, why they are as they are and what changes can be
made to them.
Each person in employment has a tax
code, which is how HMRC informs you, as an employer, on how much income tax and
National Insurance to deduct from an employee's wages each week or month,
depending on how often your business conducts its payroll function. When HMRC
does not have sufficient information on an employee or the tax code is pending,
you will then be told to implement an emergency tax code for that particular
person.
An emergency tax code assumes that
the individual is only entitled to the basic personal allowance of tax-free
earnings and that the rest of their wage is taxable at the standard rate, or
higher rate if applicable. This code does not take into account any adjustments
or entitlements the individual may have and until the correct code is sent
through, the emergency code must be used.
It is important to note that an
emergency tax code is not something to be used for an extended period of time
and once you receive notice from HMRC of the correct code to use for that particular
employee, this should be entered into your payroll software immediately.
Emergency tax codes may result in
under or overpayment of income tax by the employee because of the interim
period and in this case a refund or repayment of over or underpaid tax will be
arranged. In order to communicate an employee's tax code, HMRC will send out a
Notice of Coding and this is communicated to both the employee and the
employer. Additionally, an employee can find their tax code on their wage slip
or on their P60, which is issued to them at the end of the tax year. A Notice
of Coding is generally sent during the months of February and March, pertaining
to the coming tax year, beginning in April. This ensures that employers can
keep their payroll records up to date for all the employees on their system.
13.4 PAYE Tax Codes
- What They Mean
Tax codes are made
up of letters and numbers.
The numbers pertain to the amount of
income which may be set against tax and the letters importantly relate to the
type of allowances the employee is entitled to.
Here is a quick look at some codes:
·
L: You're entitled to the standard tax-free Personal Allowance
·
M: You've received 10% of your partner's Personal Allowance
·
N: You've transferred 10% of your Personal Allowance to your partner
·
T: Your tax code includes other calculations to determine your Personal
Allowance
· 0T: Your Personal Allowance has been used or you've started a new job
and your employer does not have the details they need
·
BR: All income from this job is taxed at the basic rate of Income Tax
·
D0: All income from this job is taxed at the higher rate of Income Tax
·
D1: All income from this job is taxed at the additional rate of Income
Tax
·
NT: You're not paying any tax on this income
·
S: Your tax is based on rates in Scotland
·
C: Your tax is based on rates in Wales
For a full list of tax codes, you may
refer to www.gov.uk
The numbers in a tax code give you
information on the total allowance amount, minus any amount which is deducted
to cover other income or benefits the employee is receiving. It is important to
understand why a tax code is made up of certain letters in particular because
this will give you important information on the employment status of your
staff. Knowing why they are on that particular code letter will also help you
answer any questions quickly and effectively, in the event of a query by the
employee.
Tax codes can change due to changes
in employment circumstances, and this should always be communicated to HMRC in
writing as a matter of urgency, in order for the tax code to be adjusted if
necessary. Not communicating such issues may mean that the employee remains on
the incorrect tax code, which may result in overpayment or underpayment of tax,
requiring adjustment at a later date. This can cause costly upset and
time-consuming effort to put it right, both for the employer and the employee.
13.5 How Do You
Send PAYE Information to HMRC?
The question of how
you send PAYE information to HMRC is a very easy one to answer, as your
software does it all for you when you submit your full payment submission at
the end of the week or month.
Provided you keep your employees'
payroll records up to date, particularly with the correct tax code, then the
deductions from wages in terms of income tax and National Insurance should be
accurate and up to date. Emergency tax codes are probably the only anomaly
here, because this is a holding period of time, until HMRC issue you with the
correct code to apply to your employee's wages.
It is important that the correct code
is inputted as soon as you receive it, taking the employee off the emergency
code. An emergency tax code often results in an employee being owed tax,
because they have overpaid during the emergency code period. Alternately, it
can also result in them owing tax, especially if they are in a high paid job.
Either way, an emergency tax code will inconvenience your employee, so reducing
the amount of time they are on it is the best way forward. Simply ensure you
forward any pertinent information to HMRC in a timely manner and ensure the
code is updated as soon as it is sent to you.
13.6 Software
Issues to Consider
Provided you have
purchased HMRC-recommended payroll software, your deduction calculations should
be accurate and up to date.
This is because such software uses
real-time (RTI). We touched upon this previously, and it basically means that
the software is updated regularly with changes, which automatically adjusts the
amount of income tax and National Insurance requirements from that employee.
This means that there is less chance of an underpayment or an overpayment and
that a problem at the end of the tax year with adjustments is less likely to
happen as a result. HMRC-recommended software is generally updated every year,
in line with changes from HMRC; however, it is important to always remain
abreast of developments yourself, too.
If you are using online software,
again make sure this is HMRC-recommended and this should be updated
automatically too, giving you peace of mind that you are working to the correct
guidelines.
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