Pay As You Earn (PAYE) is a withholding tax system on income payments made to employees. They system is provided by HM Revenue and Customs whereby Income Tax and National Insurance contributions, or NICs, are collected using deductions throughout the tax year. Deductions are made in each pay period and are based on an employee’s earnings. They are subsequently paid to HM Revenue & Customs by the employee’s employer. Deducted amounts are considered advance payments of income tax due at the end of the tax year. Any excess tax payments are refunded when tax returns are prepared. PAYE may be collected by withholding employee portions of any insurance contributions or social benefit taxes.
About PAYE
PAYE was first introduced in the United Kingdom in 1944 following trails in the early 1940s. The intent of the system was to reduce fiscal pressures during the Second World War by collecting tax from more individuals, many of whom had not paid income tax in the past. PAYE applies on all salary and other compensation payments. It is required when compensation is anticipated to reach and exceed the National Insurance Lower Income Level. The amount deducted is calculated by employers and it is based on the tax code and the applicable National Insurance category. The tax code is determined by HM Revenue and Customs and is based on an employee’s expected income and any applicable tax allowances, exemptions and reliefs expected for the given tax year.
How PAYE is Calculated
PAYE is applied to all payments an employee receives from an employer. It is levied at each pay period and for applied to each paycheque. Payments subject to PAYE include salary and wages, overtime, tips, shift pay, bonuses and commissions. Statutory sick pay and statutory maternity, paternity or adoption pay are also subject to PAYE deductions. PAYE deductions are also made on certain expense allowances that are paid out in cash, as well as any lump sum or compensation payments unless they are exempt from taxation. Non-cash items and benefits such as bonds, shares and vouchers may also be subject to PAYE deductions. In addition to deducting income tax and NICs, employers must also deduct from benefits such as student loan repayments, loan repayment made to an employee, employee pension contributions, and payments that are made under an attachment of earnings order.
How PAYE is Collected
Employers deduct tax and NICs from an employee’s pay for each pay period. Employers must also deduct Class 1 NICs, if applicable. Amounts are then paid to HM Revenue and Customs on a monthly or quarterly basis. Employers are also required to submit the Full Payment Submission (FPS) online on or before every pay day. This information lets HM Revenue and Customs know about any payments made to employees and confirm any applicable tax, NICs and other contributions or deductions that must be deducted. Payroll software is available to assist employers with calculating PAYE amounts from an employee’s pay. Employers are also required to give each employee a pay stement before or when they are paid. The payslip must include the employee’s gross pay before deductions, as well as an outline all deductions and the purpose of each deduction. The payslip must also provide the net amount payable after deductions.