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Pay As You Earn                                      through PAYE, but are taken into account in the
                                                     employee’s PAYE code. PAYE is calculated on the
                                                     employee’s earnings after deducting:
                                                     • contributions to the employer’s pension
 Summary                                             • donations to charity under the payroll giving
 Pay as you earn (PAYE) is the system under            scheme
 which income tax is deducted at source from         • the exempt portion of profit-related pay.
 wages and salaries paid to employees. The           PAYE is normally calculated on a cumulative basis,
 employer is required to calculate and deduct        ie by aggregating the earnings received so far
 income tax each time a payment is made to           during the tax year. From the aggregate earnings
 the employee. The tax deducted is then              the “tax-free pay to date” (which represents the
 remitted to the Inland Revenue monthly. At          personal allowances and reliefs available for the
 the end of the tax year the employer must           year to date) is deducted, giving the taxable pay to
 prepare annual returns and an end-of-year           date. The tax-free pay to date is found by looking
 summary.                                            up the employee’s PAYE code in the tax free pay
                                                     tables (Table A) for the tax week or month in
                                                     which the pay day falls.
                                                        The employer calculates the total tax due to
                                                     date from the tax tables SR and B to D (these
                                                     tables calculate the total tax due to date taking
Income and Corporation Taxes Act 1988                into account the lower, basic and higher rate tax
Income Tax (Employments) (Notional Pay-              bands available for the year to date). The tax to be
ments) Regulations 1994 (SI 1994 No. 1212)           deducted from the employee’s pay is calculated by
Income Tax (Employments) Regulations 1993 (SI        deducting the total tax paid to date on the last pay
1993 No. 744)                                        day.
                                                        In certain instances PAYE will be operated not
                                                     on a cumulative basis, but separately for each
Practical Guidance                                   payday. This may apply, for example, where an
                                                     employee’s code has altered, and the use of the
Employees                                            new code on a cumulative basis would lead to a
An employer is only required to operate PAYE on      disproportionate amount of tax being deducted.
wages and salaries paid to employees. PAYE is not       Whenever the employee is paid, details of the
deducted from payments made to self-employed         taxable earnings and PAYE deductions must be
individuals. An employee is:                         recorded on the employee’s deductions working
• someone who works under a contract of service,     sheet P11 (or substitute).
   whether written or implied, or
• an office holder, such as a company director,
   whose salary is taxed under Schedule E.           PAYE Code
Someone who works under a contract for services      The employee’s code is determined by adding the
is self-employed.                                    available allowances and reliefs, and deducting
                                                     amounts from which tax cannot be deducted,
Calculating the PAYE Due                             such as benefits in kind, ie company cars. This
PAYE must be deducted from cash payments such        enables benefits to be taxed by restricting the
as wages, salaries, bonuses, etc. It must also be    allowances set against the employee’s cash
operated on readily convertible assets, such as      earnings. Although the notice of coding sent to
cash vouchers, premium bonds, quoted shares,         the employee will set out how the PAYE code is
etc. Other benefits in kind are not taxed directly   calculated, the employer will only be advised of

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the code number. Most codes will have a suffix              If the employer is a small business employer,
letter, which indicates which allowances are given       remittances can be made quarterly, rather than
in that code number.                                     monthly. Thus the PAYE due for the three months
   If the value of the employee’s benefits exceeds       to 5 July are payable by 19 July. A small business
available allowances, his or her code will have the      employer is one whose average PAYE and
prefix “K”. This is a direction to the employer not      National Insurance contributions are, or are
to deduct tax-free pay from the employee’s               expected to be, less than £1500 per month.
earnings, but to add additional taxable pay. The            Interest may be charged on any PAYE not paid
benefits are thus taxed through the PAYE system,         by 19 April following the end of the tax year.
avoiding the need to collect additional tax
through self-assessment.                                 Returns
   Once a code has been issued for an employee,          At the end of the year the employer must
the employer must continue to use that code              complete an end-of-year summary form P14 for
unless notified of a new code by the PAYE office.        each employee. This is a three-part document
Blanket instructions are issued to enable codes          which includes details of pay and tax deducted.
with suffix letters (other than the suffix letter “T”)   The details of PAYE deducted for each employee
to be updated following changes in personal              are transcribed onto the end-of-year return form
allowances announced in the Budget.                      P35. The employer is required to certify that the
                                                         relevant returns have been made, and to send
New Employees                                            form P35 and two copies of form P14 to the Inland
When a new employee joins, he or she may bring           Revenue by 19 May following the end of the tax
parts 2 and 3 of form P45 from his or her previous       year. These returns also include details of
employer. These include details of pay and tax in        National Insurance contributions.
the previous employment, and the employee’s                 The employer must also give to each employee
PAYE code. These details are entered on the              who was employed at the end of the tax year, a
employee’s deductions working sheet P11 (or              certificate of pay and tax deducted — P60 — by 31
substitute), enabling the employer to deduct tax         May following the end of the tax year. The P60 is
at the correct rate for the rest of the tax year. Part   normally the third copy of form P14.
3 is sent to the PAYE tax office.                           If the end-of-year return is not submitted by the
    If the employee does not have a P45, he or she       deadline, a penalty of £50 per 100 employees may
should complete form P46. The employer should            be charged for each month that the return is late
follow the instructions on form P46 to ascertain         (although a seven day period of grace is allowed
which PAYE code to use, and should send form             by concession). If the return is over 12 months
P46 to the PAYE office, which will issue a new code      late, a penalty equal to the PAYE and National
if necessary. The basic rules are:                       Insurance contributions unpaid by 19 April
• the emergency code (461L for 2002/2003)                following the tax year may be charged.
   should be used if this is the employee’s first job
   since leaving full-time employment
• the emergency code (461L for 2002/2003)
   should be used on a week 1/month 1 basis if this      Questions and Answers
   is the employee’s only or main employment             Q Harry is taken on to work for one week only.
• code BR (under which tax is deducted at the              Need PAYE be deducted from his pay?
   basic rate with no allowances) should be used if      A If Harry’s pay is less than the PAYE threshold,
   the employee has another job or receives a              PAYE need not be deducted. If it is more than
   pension.                                                the PAYE threshold, PAYE should be deducted
                                                           using either the emergency code, or the basic
Leaving Employees
                                                           rate code if it is known that Harry has another
When an employee leaves, the employer must
complete a P45 giving details of the employee’s
                                                         Q What is the emergency code?
pay and tax deducted. Part 1 is sent to the PAYE
                                                         A The emergency code gives the employee just
office and Parts 1A, 2 and 3 are given to the
                                                           the personal allowance. For 2002/2003 the
employee. The employee will retain part 1A, and
                                                           personal allowance is £4615, and the emer-
can give the remaining two copies to his or her
                                                           gency code is 461L.
new employer.
                                                         Q What happens if, following a change of code
Remittances of PAYE                                        number, an employee has paid more tax than
The PAYE due for all employees for pay days                is due this pay day?
falling within a tax month must be remitted to the       A The employer will refund the tax overpaid to
Collector of Taxes within 14 days of the end of the        the employee. There is no limit on the amount
tax month (together with the National Insurance            of refund that can be made in this way. The
contributions due), using the book of pay slips            employer may deduct the refund from the
provided for this purpose.                                 remittance of PAYE and National Insurance

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   contributions due to the Collector of Taxes,                            published by the Inland Revenue.
   and if it exceeds this amount, may recoup the                           Advice may be obtained from the employer’s
   shortfall from the Inland Revenue.                                      PAYE office, or by telephoning the employer’s
                                                                           helpline on tel: 08457 143143.
Key Facts
• The employer must deduct PAYE from wages                                 The following forms will be needed:
  and salaries paid to employees.                                          P11: Deductions Working Sheet
• The PAYE is calculated from tax tables using the                         P14: End-of-year Summary
  employee’s PAYE code.                                                    P30B: Pay Slip
• The PAYE deducted must be remitted to the                                P32 or P30BC: Payment Records
  Collector of Taxes monthly (or quarterly),                               P35: End-of-year Return
  together       with     National       Insurance                         P45: Details of an Employee Leaving Work
  contributions. Interest will be charged on any
                                                                           P46: Employer’s Notice to Tax Office
  PAYE not paid by 19 April following the end of
                                                                           P60: Certificate of Pay, Income Tax and National
  the tax year.
• Annual returns must be made at the end of each                           Insurance Contributions.
  tax year within strict deadlines. Automatic
  penalties will be charged if returns are late.

Further Information

CWG1: Employer’s Help Cards published by the
Inland Revenue.
CWG2: Employer’s Further Guide to PAYE and NICs

  Taken from Croner’s A–Z of Business Regulation and Compliance — an indispensable guide to everything you need to know for your
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