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PAYE System – Supplementary Notes Scope The PAYE system collects


PAYE System – Supplementary Notes Scope The PAYE system collects

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									                     PAYE System – Supplementary Notes


The PAYE system collects the correct amount of tax over the year. It applies to
most cash payments [other than reimbursed expenses] and to certain non-cash
payments. It applies to:

             wages & salaries

             taxable lump sum payments on leaving

             most lump sum payments on joining

             round sum expense allowances

             payments instead of benefits

             any readily convertible asset

It is the employer’s duty to deduct income tax from his employees’ pay. If he
fails to do this,

        he must pay over the tax which he should have deducted

        he may be subject to penalties

        interest will run from 14 days after the end of the tax year in which tax

        was underpaid

Inland Revenue officers can inspect employers’ records to check that the
correct amounts of tax are being deducted and paid to the Revenue.

How PAYE works

To operate PAYE, the following are needed:

        deductions working sheets

        codes for employees that reflect the tax allowances to which the

        employees are entitled

        tax tables

On any payday, the PAYE code is used in conjunction with the tables to work out
the tax due on a cumulative basis; i.e. the running total of tax paid is compared
to the tax due on total emoluments to date. The difference between tax due and
tax paid is the amount of tax deducted (or repaid) on that payday.

Note: if an employee has a Week 1/Month 1 tax code, tax on each day is worked
out on that payday as if it were the first payday in the tax year, NOT on a
cumulative basis.

Student loan repayments are also collected under PAYE.

PAYE codes

An employee is normally entitled to various allowances. Under the PAYE system,
a proportion of these allowances is set against his/her pay each payday. The
employee’s tax code is looked up in the Pay Adjustment tables (Table A) to
determine the amount to offset against his/her pay that month.

Examples of codes are:

L      tax code with basic personal allowance

T      tax code where Inland Revenue reviewing other items in tax code

K      prefix where allowances are less than benefits

The codes BR, DO and OT are used where there is a second source of income
and all allowances have been used in a tax code which is applied to the main
source of income.

Generally, a tax code number is arrived at by deleting the last digit in the
amount of the tax free allowances. Every individual is entitled to a personal tax
free allowance of £4,745, so the code for someone with no other allowance is

Also, the code number will be restricted to reflect:


       small amounts of untaxed income

      unpaid tax from earlier years – must gross up the amount of unpaid tax at
      the taxpayer’s estimated marginal rate of tax and deduct from the code

The employee will receive a notice of coding which details all items reflected in
the code. The employer will simply receive a notice of the final figure only.

Edward is a 35 year old single man (suffix letter L) who earns £12,000 p.a. He
has benefits of £1,500 and has unpaid tax for 2004/05 of £125. This will be
collected in 2005/06 through his tax code. Edward pays tax at the marginal rate
of 22%. What is Edward’s PAYE code for 2005/06?

Codes are determined and amended by the Revenue who advises them to
employers. The employer must use the code until any amended instructions are
received from the Revenue.

Using the code in conjunction with Table A gives the employee 1/52nd or 1/12th
of his/her allowances against each week’s/month’s pay. However, as PAYE is
calculated on a cumulative basis, if an employee is paid for the first time in the
tax year in June, then three months’ allowances will be offset against gross pay
that month.

K codes increase taxable pay instead of reducing it, as benefits exceed
allowances. There is a tax deduction limit of 50% of actual remuneration on that
payday to avoid causing hardship.

Employer’s responsibilities: Year End

At the end of the tax year, an employer must provide each employee with a form
P60, by 31 May following the tax year which shows:

       total taxable emoluments for the year

       tax deducted

       code number

       national insurance number

       employer’s name and address

After the end of each tax year, the employer must send the Revenue:
   a) by 19 May
             P14 End of Year Returns (showing same details as P60’s)
             Form P35 – summary of tax and NI deducted

   b) by 6 July
            P11D Forms – benefits etc. for directors and employees paid over
            £8,500 p.a.
            P9D Forms – benefits etc. for excluded employees

Copies of P11D’s and P9D’s must also be provided to the employees by 6 July.
These forms detail the full cash equivalent of all benefits, so the employee may
put these on his/her self-assessment tax return. Specific reference numbers
for the entries on the P11D are also used on the employee’s self-assessment tax

Usually, the full value of any assessable benefits are entered on the P11D and
employees make a separate claim to deduct expenses incurred wholly, exclusively
and necessarily for the purposes of the employment. Alternatively, employers
reach an agreement with the Revenue that certain expenses reimbursed to
employees are tax deductible and do not need to be entered on the P11D. This is
a “P11D Dispensation”.

PAYE settlement agreements (PSA’s)

These are arrangements under which employers can make single payments to
settle their employees’ income tax liabilities on expense payments and certain
benefits. Benefits may be included in a PSA if the Inspector considers them:

      Minor, e.g. small gifts

      Irregular, e.g. relocation payments of over £8,000

      Benefits which it is impractical to apply PAYE to or identify the amount
      attributable to a particular employee, e.g. free dental care

Items covered by a PSA do not have to be included on either P9D/P11D or
employee’s tax return.

PSA’s cannot be used to settle tax on:

      Cash payments of wages, salaries or bonuses

      Major benefits provided regularly for the sole use of individual

      employees (e.g. company cars)

      Round sum allowances


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