Pay As You Earn

PAYE (Pay As You Earn) is the HMRC system for collecting Income Tax and National Insurance contributions from employees' pay in real time. Employers must register with HMRC as an employer, operate PAYE from the first payday, deduct the correct Income Tax (using the employee's tax code) and NIC (Class 1), and submit a Full Payment Submission (FPS) to HMRC on or before each payday under Real Time Information (RTI). Employers also pay employer's Class 1 NICs on earnings above the secondary threshold and contribute to the Apprenticeship Levy if payroll exceeds £3 million. Errors in PAYE can result in penalties and interest. Employees who believe they have overpaid tax can claim a refund via their HMRC personal tax account or by submitting a self-assessment return. New employees must provide a P45 from their previous employer or complete a starter checklist.

What it means in practice. PAYE is a reporting obligation as much as a payment one. The Full Payment Submission must reach HMRC on or before the day you pay someone, not at the end of the month, and a late FPS attracts a penalty even if the tax itself is paid on time. Tax codes do most of the work: HMRC issues them, the employer applies them without question, and if a code is wrong the fix comes from HMRC rather than the payroll department. An emergency code applied to a new starter with no P45 usually corrects itself once HMRC catches up, and any overpaid tax comes back through the payroll.

A worked example. Sana takes on her first employee in June. She registers as an employer before the first payday, receives a PAYE reference, and runs payroll software that files an FPS each time she pays wages. Her employee has no P45, so she uses the starter checklist and the code it indicates. She pays the deductions to HMRC by the 22nd of the following month. Because her total employer NIC bill is modest, she also claims the Employment Allowance, which reduces her employer NICs by up to £10,500 for the year.

Common pitfalls. Paying someone cash "off the books" makes the employer liable for the tax and NICs that should have been deducted, plus penalties and interest — the liability sits with the business, not the worker. Treating regular contractors as self-employed when they are really employees produces the same exposure. And getting a benefit in kind wrong, such as a company car or private medical cover, is a common source of unexpected assessments years later.

How it relates to other terms. PAYE collects Income Tax and National Insurance together, and the payroll records it generates are the evidence used to check minimum wage compliance. It is administered by HMRC and is entirely separate from your filings at Companies House. Employers taking on staff must also run right to work checks and set up pension auto-enrolment.

What to do next. Read our PAYE basics guide before your first payday, and work through hiring your first employee, which covers registration, contracts, and insurance. Keep everything you file using employment records, since HMRC can look back several years.