What is PAYE?
Pay As You Earn (PAYE) is the tax collection system used in the UK for employees. Under PAYE, your employer deducts income tax and National Insurance contributions (NICs) directly from your wages on a weekly or monthly basis and pays them to HMRC on your behalf.
The system has been with us since the first dedicated tax office, Centre I in East Kilbride, was established to collect taxes directly from employers. Over the decades it has become increasingly sophisticated, but you can still end up paying too much or too little tax under PAYE. Knowing how it works is worth the effort.
What you pay tax on under PAYE
Income subject to PAYE deduction includes:
- Wages and salaries, including commission, fees, bonuses, and overtime
- Tips and service payments
- Reimbursed expenses and travelling time payments
- Benefits in kind (for example, a company car or private medical insurance)
- Holiday pay, sick pay, maternity pay, and paternity pay
- Redundancy payments, though the first £30,000 may be free of tax
- Incentive payments and some termination payments
Employer responsibilities
The employer is responsible for operating PAYE and remitting the amounts deducted to HMRC within 14 working days of the end of each month. They have two key duties: to deduct the correct amount of tax based on each employee's individual tax code, and to issue certification of that deduction to the employee.
The tax code is what tells the employer how much of each employee's wage to treat as tax-free and how much to deduct at the appropriate rate. The purpose of the code is to award the employee their individual personal allowance, leaving the balance to be taxed.
Understanding your tax code
Your tax code appears on your payslip and on correspondence from HMRC. The number in the code typically represents your tax-free allowance divided by ten. For example, a code of 1257L means you have £12,570 of tax-free income, the standard Personal Allowance, leaving everything above that subject to tax at the appropriate rate.
The letter suffix tells your employer the type of taxpayer you are:
| Code | What it means |
|---|---|
| BR | Basic rate tax (currently 20%) is deducted from all income from this source. Your personal allowance is being used elsewhere |
| D0 | Higher rate tax (40%) is deducted from all income. Typically used where you have income from other sources that already uses your allowances and basic rate band |
| K | Your total deductions (such as benefits in kind) exceed your allowances, so extra tax must be deducted to collect what's owed. For example, K460 means an additional £4,600 of income is being taxed on top of your earnings |
| L | You are entitled to the standard Personal Allowance only, the most common code suffix |
| T | Used when HMRC has flagged the code for review, or where your allowances have been adjusted because your income exceeds the income limit. Also used as OT (no allowances) or NT (no tax) |
| P | You receive the full personal allowance and are aged between 65 and 74 at some point in the tax year |
| Y | You receive the full personal allowance and are aged 75 or over at some point in the tax year |
Key PAYE forms explained
P45: When you leave a job
When you leave employment, your employer must give you a P45, which shows your PAYE code and the cumulative pay and tax deducted up to your leaving date. You give this to your next employer so that the cumulative tax system can continue. Keep your copy, as you may need it for a Self Assessment return.
P46 / Starter Checklist: Starting a new job without a P45
If you start a job without a P45, your employer will ask you to complete a Starter Checklist (this replaced the old P46 form). This gives HMRC the information needed to issue the correct tax code. Until a code arrives, your employer may use an emergency code.
P60: End of year certificate
After each tax year ends, and no later than 31 May, your employer must give you a P60 showing your total pay and all tax and National Insurance deducted during the year. Keep this document safe, as it is required if you need to file a Self Assessment return.
P11D: Benefits in kind
If you receive benefits in kind from your employer (company car, health insurance, etc.), HMRC treats these as additional income. Your employer must report details of all taxable benefits and expenses on a P11D and provide you with a copy by 6 July following the end of each tax year. You need this to complete any Self Assessment return.
Thinking about running your own payroll? Our dedicated payroll team at our Leith office, headed by Gaelle Malarde, can advise on all aspects of running a staff payroll scheme, whatever the size of your workforce. Get in touch to discuss whether an in-house or managed payroll service makes more sense for your business.