The Basics of PAYE Tax

PAYE is the abbreviation of the “Pay As You Earn” tax scheme introduced in the United Kingdom in 1944. The scheme was introduced by the Inland Revenue of UK and is used for collections of Income Tax and National Insurance Contributions (NIC) from employees. Employers are responsible for collecting the income tax and NICs from their employees throughout a tax year and remitting the monies to Her Majesty’s Revenue and Customs, which was created in 2004 after the merger of HM Customs and Excise and the Inland Revenue. The amount of tax deducted from each employee will depend on his or her earnings for that particular tax year.

Every employer in the United Kingdom should register as an employer with the tax authority in order to administer the Pay As You Earn scheme on behalf of their employees. PAYE deduction is mandatory by law if an employee has earnings at or above the PAYE threshold. The Registration process is quite straightforward and could be done up to four weeks before the first qualifying employee is engaged by the company. The deductions are made in accordance to the payroll schedule of the company, which can be on a weekly or monthly basis depending on the pay schedule of the company.

PAYE tax
The employer should keep a track of all the income tax and NIC deductions of their employees and forward the dues to the tax authority on or before the 19th of every month following the pay period of the company. Small businesses that are quarterly liable to pay income tax and NICs (remitting less than 1,500 pounds per quarter) can make arrangements with the authority to pay their dues every three months instead of paying on a monthly basis. The financial tax year in UK begins on the 6th of April and ends on the 5th of April the following year. Each tax year is divided into 53 tax weeks for easy calculation purposes.

The calculation of income tax is done by using the current tax code system. Each employee is allocated a tax code on joining a company. Special conditions and circumstances of each employee is represented in his or her tax code. The income tax deductions are calculated on a cumulative basis during a specific tax year. This is done by using the employer’s manual tax tables or using a payroll software package. Each employee has a tax free allowance each pay week or month, and this can be determined from the tax table by way of the employee tax code.

The employer will calculate the cumulative tax free allowance of the employee during a specific period of time, and deduct it from the cumulative gross pay that is due to the employee for that particular period of time. This is how the income tax is being calculated by an employer. The employer will deduct the income tax and issue the employee with a payslip showing the amount deducted as income tax. Then the collected amounts will be paid to the tax authority as per the tax schedule. There approved calculators and the issuance of payslips are essential functions of the payroll software. This system is adopted by the majority of employers in the UK, in order to ensure compliance and accuracy with the tax rules of the country.

The other important area of pay as you earn administration is in deducting national insurance contribution dues from the employees. NICs are calculated according to the gross income earned per specific pat period and not on a cumulative basis. The amount deducted is determined according to the gross pay of the employee and the National Insurance Deduction table. In addition to the deduction from the employee, the employer also has to pay an employer national insurance contribution.

The P45 is the certificate which is given to an employee once he or she leaves an employment. It will show the cumulative tax and gross pay deductions from the day the employee joined the company until the day he or she left the company. The P45 includes the employee tax code and should be entered into the employee tax records, in order to enable the new employer to continue the income tax schedule.


All in all, the PAYE tax system is considered one of the most efficient tax systems in the world.