The Pay As You Earn (PAYE) system in the UK provides for suitable amounts of tax and national insurance to be deducted from the salaries of employees during a tax year. The employer is responsible for operating the system and must pay over the tax deducted to HM Revenue and Customs (HMRC) within fourteen days after the end of the tax month. An extension of three further days is permitted in the case of electronic payments.
As the tax year in the UK runs to 5 April, tax months also end on the 5th of each month. Payments to HMRC by employers in respect of tax deducted from staff wages are also calculated on the basis of tax months. Where the payments to HMRC are not in excess of £1,500 per month on average, quarterly payments are permitted.
The PAYE system applies to payments that are assessable on employees as income from their employment, including not only wages, bonuses or commission but also payments in the form of assets that are readily convertible into cash or vouchers exchangeable for cash. The types of asset covered by PAYE include more exotic payment methods such as gold bars. Payments in the form of company shares are also covered by the system, though shares granted to an employee under a share incentive scheme would not be included in the salary for PAYE purposes.
The amount of tax deducted from the wages of a particular employee under the PAYE system is determined by that individual’s tax code. The tax code shows the amount of income that the individual can earn in the tax year, based on personal circumstances and other factors.
The tax code takes into account the individual’s tax free personal allowance, other tax reliefs and tax deductible expenses. The tax code is also adjusted so as to effectively collect tax on items not included in the wages for PAYE purposes, for example taxable benefits in kind. The tax code is also used to collect tax underpaid or overpaid in respect of previous tax years.
The tax code consists of the adjusted tax-free amount relating to the individual, divided by ten and rounded down to the nearest whole number. This is followed by a suffix as follows:
The L code indicates that the individual is entitled to the basic personal allowance; The P code shows that a person is entitled to the personal allowance for people aged 65 to 74; The Y code is given to taxpayers entitled to the personal allowance for individuals aged 75 or more; The BR code indicates that the employer should deduct basic rate tax from payments made to the employee; and The NT code is an instruction the employer not to deduct any tax from that particular employee.
Certain codes have a prefix rather than a suffix. The prefix D is used in collecting higher rate tax from the taxpayer, and the prefix K is used to collect an excess of benefits and underpayments over the available allowances.
The PAYE system is operated by applying two tax tables (called table A and table B) which were originally in the form of booklets but are now more likely to be computer files. Table A, the pay adjustment table, shows the amount of tax-free pay to which a particular employee is entitled, up to a particular week or month of the tax year. Table B, the taxable pay table, shows the tax liability on the taxable income arrived at by deducting the tax free amount (obtained by consulting table A) from the gross pay to date in the tax year.
At the end of the tax year, the employer must send to HMRC a Form P35 listing the employees and their gross pay, tax and national insurance paid in the tax year. The Form P35 must be submitted by 19 May following the tax year. The Form P60, showing gross pay and tax deducted from an employee in the year, must be given to the employee by 31 May following the end of the tax year. The Form P14, showing similar information to the P60 about the employee, must be sent to HMRC.
Another part of the PAYE system is the P45 form given to employees who leave the employment during the tax year. The form shows the employee’s tax code, gross pay to date (since the beginning of the current tax year) and tax deducted to date. A copy of Form P45 is sent to HMRC, while the employer keeps one copy and sends two to the leaving employee. The employee must supply a copy of the P45 to the next employer to enable this employer to operate PAYE correctly in respect of that employee.
Where an employee joins a new employer and does not have a P45 from a previous employment within the current year, that new employee must complete a Form P46, providing details to enable PAYE to be operated correctly as soon as possible after that new employment begins. On Form P46 the new employee certifies that this is the first employment the individual has had in the current tax year; or that the individual has had another job or drawn jobseeker’s allowance or incapacity benefit in the tax year; or alternatively that the individual currently has another employment or is receiving a pension.
An employer may negotiate a PAYE Settlement Agreement with HMRC under which a lump sum is paid to cover the tax liability on minor or irregular benefits provided to employees, where it would be impractical to operate the PAYE system on these benefits.
HMRC is currently consulting employers and other interested parties on improving the operation of the PAYE system, for example by collecting real time information, thereby reducing administration costs and improving the accuracy of the PAYE system.
HM Revenue and Customs www.hmrc.gov.uk
“Taxation: Finance Act 2010”, by Alan Melville, sixteenth edition, 2011