HMRC PAYE: a guide for employees and employers

This wise statement from one of America’s founding fathers over two hundred years ago has proven to be only too prescient. While the methods of collection may differ from country to country, taxes are an inescapable reality of life.

This article covers the United Kingdom’s income tax collection method of choice: the PAYE scheme.

What is PAYE and how does it work?

The United Kingdom adopted the pay-as-you-earn, or PAYE, method of income tax collection in the mid-20th century. Since then, UK tax residents’ income tax is paid directly from their salary. 

This is as opposed to France, for example, who did not implement a PAYE system until 2019. Previously, they opted instead for yearly tax filings and one-off payments. Taxpayers paid their tax bill in one lump sum (or could request to pay quarterly). 

And the United States has its own convoluted tax system, that combines some PAYE, some end-of-year filing, and different state and federal tax requirements.  

PAYE is a much more efficient system that removes the burden from taxpayers.

How PAYE works

Employers pay their employees, and the government deducts income tax and other expenses (such as National Insurance) from the employee’s salary before they receive their payslip. But not everyone pays the same amount.

(If you want more information on how National Insurance contributions are calculated, check out HMRC’s guide.)

The employer (usually the company’s finance team or payroll department) is in charge of calculating the amount to take out of the employee’s salary.

Income tax is, of course, based on your earnings. The more you earn, the more tax you pay. But it’s not a flat fee; income tax is based on a progressive tax rate. This system is designed to keep things fair: lower-income earners pay less tax than high-income earners. 

This year, the tax year goes from 6 April to 5 April. Here are the income tax rates and bands as of April 2023:

This is a simple system designed for efficiency; there’s no need for individuals to save up money for the end of the year to send to HMRC. The benefits are mutual: employees don’t need to save and then pay a big chunk of money at the end of the year, and HMRC receives money year-round.

If you do owe tax at the end of the financial year in addition to what’s been taken out via PAYE, it’s usually due to special circumstances that you’ll already be aware of (such as self-employment). In that case, make sure you fill out a Self Assessment with HMRC.

So now we’ve got a handle on how the PAYE system works, let’s take a look at how it impacts employees and employers.

HMRC PAYE for employees

As stated above, HMRC collects income tax and other expenses directly from your salary with the pay-as-you-earn scheme. 

This means that employees don’t pay their income taxes in one lump sum, but in even payments throughout the year. 

And in reality, employees won’t actually see this money at all; it’s taken out of your monthly salary before it even hits your bank account. 

You’re not taxed on your entire salary. Up to £12,570 (for the 2023-2024 tax year) is exempt from income tax, so the tax only comes out of the wages earned above that amount. This is called the standard Personal Allowance. 

There are, as always, exceptions to this rule. For example, if you earn above £100,000 then your Personal Allowance will be lower. If you have a disability, you may qualify for an exemption and your Personal Allowance will be higher.

You’ll have an individual tax code that defines how much tax is taken out of your paycheck. If your salary changes or you switch jobs, HMRC will automatically update your tax code. But you have the option to correct it should you find it’s inaccurate. 

In concrete terms, employees don’t have much to worry about when it comes to income tax. You’ll need to be sure that your tax code is correct, figure out if you qualify for special exemptions, and alert your employer and HMRC if you’ve found that you’ve underpaid your income tax.

But the bulk of the work falls to employers, as we’ll see in the next section.

HMRC PAYE for employers

Because income tax comes out of the employee’s salary, employers have a large part to play in the PAYE scheme. 

You need to make sure that the proper amount comes out of employees’ salaries based on their individual earnings. You also need to report to HMRC and keep track of deductions.

PAYE obligations for companies

1. Register for PAYE 

2. Pay your employees

3. Deduct from employees’ pay

4. Report to and pay HMRC

These are just the broad strokes. For more detail, refer to HMRC’s guide to PAYE for employers.

Employers are charged with calculating their employees’ personal tax contributions.

Luckily, there are tools to help.

You can invest in a payroll software that automates PAYE calculations. And as you know, the more you automate, the more streamlined and efficient you are.

Or, if you go the manual route, HMRC provides calculators to help you figure out how much to allocate for PAYE allowances.

You can also outsource your payroll and PAYE tasks to an accountant or accountancy firm.

No matter how you decide to fulfil your PAYE responsibilities, you’ll have to keep meticulous records for at least three tax years. If HMRC investigates and finds your records aren’t up to standard, you may be liable for penalties or fines up to £3,000. 

How to make payments

Employers are not only tasked with calculating their employees’ income tax, but they’re also responsible for sending in PAYE payments to HMRC.

Here are the important facts to remember about your PAYE bill:

• You must pay HMRC monthly unless you qualify for quarterly payments

• The deadline to send in payments is the 22nd of the next tax month

• If you make any errors, HMRC may charge interest or a fine

• Any overpayment declarations should be submitted to HMRC by the 19th of the next month

• You can pay your bill in a myriad of ways: corporate card, by cheque, online or telephone transfer, at your bank, or even set up a direct debit

When in doubt, contact HMRC if you have any questions or doubts regarding your PAYE payments.

Where does PAYE money go?

HMRC is transparent about where income tax goes. If you would like to read their in-depth report, you can find it here: How public spending was calculated in your tax summary.

In short, UK income tax is spent on public services, with Health being the top category. In order of funds received, here are the top five categories:

1. Health

2. Welfare

3. State pensions

4. Education

5. National Debt interest

The numbers fluctuate every year because income tax depends on how many people are working and how much they’re earning. But overall, the top five categories are usually some combination of the ones listed above.

Render unto Caesar…

Taxes are the inevitable (and sometimes painful) result of living in a civilised society, dating back to the ancient Egyptians. 

Luckily for modern humans, we at least have tools that take the headache out of calculating how much we owe. We also have tools that make accounting and all finance processes simple and efficient.

Make life easy for yourself or your finance team and automate your processes wherever possible. The more you embrace digitalisation and automation, the more efficient your finance team will be.