PAYE - Pay As You Earn (UK)
HMRC's system for collecting income tax and National Insurance contributions directly from employee wages at each pay run, ensuring tax is paid in real time rather than as a lump sum at year end.
What Is PAYE (Pay As You Earn)?
Key Takeaways
- ✓PAYE is the UK's income tax collection mechanism where employers deduct income tax and National Insurance contributions (NICs) from employee wages before paying them, then remit the deductions to HMRC.
- ✓Over 31 million UK employees are paid through PAYE, making it the primary way HMRC collects income tax from employed individuals.
- ✓Employers are legally responsible for operating PAYE correctly. Getting it wrong means the employer owes the underpaid tax, not the employee.
- ✓The system uses tax codes (like 1257L) to calculate the correct deduction for each employee based on their personal allowance, benefits in kind, and other adjustments.
- ✓Since 2013, PAYE operates through Real Time Information (RTI), requiring employers to report pay and deductions to HMRC with every pay run rather than at year end.
PAYE is how the UK government collects income tax from employees. Instead of workers receiving their full salary and paying tax later, employers calculate and deduct the tax at source during each pay run. The deducted amount goes to HMRC along with National Insurance contributions. The system has been running since 1944. It was introduced during World War II as a temporary measure to improve tax collection. It became permanent because it worked. Tax revenue flowed steadily instead of arriving in unpredictable lump sums. For employers, PAYE isn't optional. Every business that pays employees must register as an employer with HMRC, set up PAYE, and run payroll correctly. This applies from the moment you hire your first employee who earns above the personal allowance threshold. The mechanics are straightforward in principle: apply the employee's tax code, calculate the tax and NI due, deduct it from gross pay, report it to HMRC via RTI, and pay HMRC by the 22nd of the following month (or 19th if paying by post). In practice, handling tax code changes, starter declarations, student loan deductions, statutory payments, and year-end reporting makes PAYE one of the most detail-heavy employer obligations in the UK.
Understanding PAYE Tax Codes
Tax codes tell employers how much tax-free pay an employee gets before deductions begin. HMRC issues them, and employers must apply them exactly as received.
How tax codes work
The most common tax code is 1257L for the 2024-25 tax year. The numbers (1257) represent the tax-free amount in tens of pounds: GBP 12,570 per year. The letter (L) indicates the employee is entitled to the standard personal allowance. Employers divide the annual tax-free amount by the number of pay periods (12 for monthly, 52 for weekly) to calculate the tax-free pay per period. Any earnings above that threshold are taxed at the applicable rate: 20% basic, 40% higher, or 45% additional.
Common tax code letters
L means the standard personal allowance applies. M means the employee has received a Marriage Allowance transfer from their spouse. BR means all income is taxed at the basic rate (20%) with no personal allowance, common for second jobs. D0 means all income is taxed at the higher rate (40%). 0T means no personal allowance (used when HMRC doesn't have enough information or the allowance is fully used up). K means the employee has deductions (like benefits in kind) that exceed their personal allowance, so tax is added to their pay. W1 or M1 suffixes indicate an emergency or week 1/month 1 basis where cumulative calculations don't apply.
When tax codes change
HMRC sends updated tax codes via the employer's PAYE online account or through payroll software. Common triggers: the employee starts receiving a company car (taxable benefit), their student loan plan changes, they claim Marriage Allowance, or HMRC identifies an underpayment from a previous year. Employers must apply new tax codes from the next pay run. They can't backdate or average them unless HMRC specifically instructs it. If an employer receives a tax code they think is wrong, they should apply it anyway and tell the employee to contact HMRC directly.
UK Income Tax Rates and Bands (2024-25)
PAYE deductions follow the same income tax bands that apply to all UK taxpayers. These rates have been frozen since 2021.
| Band | Taxable Income | Rate | Notes |
|---|---|---|---|
| Personal Allowance | Up to GBP 12,570 | 0% | Reduced by GBP 1 for every GBP 2 earned above GBP 100,000 |
| Basic Rate | GBP 12,571 to GBP 50,270 | 20% | Applies to most employees |
| Higher Rate | GBP 50,271 to GBP 125,140 | 40% | Personal allowance fully withdrawn at GBP 125,140 |
| Additional Rate | Over GBP 125,140 | 45% | No upper limit |
Employer PAYE Obligations
Running PAYE involves several responsibilities beyond just deducting tax from wages.
- Register as an employer with HMRC before your first payday. You can register up to 2 months in advance. HMRC issues an employer PAYE reference number and an Accounts Office reference number.
- Use HMRC-recognized payroll software that can calculate tax and NI deductions, produce payslips, and submit RTI returns electronically. Free basic PAYE tools are available from HMRC for employers with fewer than 10 employees.
- Report employee pay and deductions to HMRC on or before each payday via a Full Payment Submission (FPS). Late FPS submissions trigger automatic penalties.
- Pay HMRC the total tax and NI deducted by the 22nd of the following month (electronic payment) or 19th (cheque/post). Small employers paying less than GBP 1,500/month can pay quarterly instead.
- Process new starters using their P45 from their previous employer or a starter declaration if they don't have a P45. Apply the correct tax code based on the information provided.
- Issue P45s to leavers and P60s to all employees still employed on April 5 (the last day of the tax year). P60s must be issued by May 31.
- Submit an Employer Payment Summary (EPS) by the 19th of the following month if you need to report statutory payments reclaimed, CIS deductions, or NICs holiday credits.
PAYE Payment Deadlines and Penalties
HMRC enforces strict deadlines for PAYE payments and RTI submissions, with escalating penalties for non-compliance.
Monthly payment deadlines
Electronic payments: due by the 22nd of the month following the tax month. The PAYE tax month runs from the 6th to the 5th (e.g., tax month 1 is April 6 to May 5, with payment due by June 22). Postal payments: due by the 19th. Quarterly payments: available if your average monthly PAYE liability is under GBP 1,500. Quarterly deadlines are July 22, October 22, January 22, and April 22.
Late payment penalties
HMRC charges penalties based on the number of defaults in a tax year. The first late payment in a tax year doesn't attract a penalty (a "free pass"). The second to fifth defaults cost 1% of the amount unpaid. The sixth to tenth defaults cost 2%. The eleventh and twelfth defaults cost 3%. Defaults over 6 months late attract an additional 5% penalty, and over 12 months late another 5%. Interest accrues on all unpaid amounts from the due date.
RTI late filing penalties
Late FPS submissions trigger automatic penalties. For employers with 1-9 employees, the penalty is GBP 100 per month. For 10-49 employees, it's GBP 200/month. For 50-249, it's GBP 300/month. For 250+, it's GBP 400/month. Penalties accrue monthly until the FPS is filed or the default is explained. HMRC may also charge penalties for inaccurate FPS submissions if they believe the employer was careless or deliberate in providing wrong information.
Handling New Starters and Leavers
The PAYE process for employees joining or leaving your company involves specific documentation and reporting steps.
New starters
When a new employee joins, ask for their P45 from their previous employer. The P45 shows their tax code, total earnings, and tax paid so far in the tax year. Enter this information into your payroll software to continue their cumulative tax calculation seamlessly. If they don't have a P45 (first job, returning from abroad, or lost it), they must complete a starter declaration choosing one of three statements: A (this is their first job since April 6), B (this is their only job now), or C (they have another job or pension). The statement chosen determines the initial tax code: 1257L for statement A or B, BR for statement C.
Leavers
When an employee leaves, process their final pay run, deduct the correct tax and NI, and issue a P45 with parts 1A, 2, and 3. Send part 1 to HMRC (this happens automatically through your FPS), give parts 1A, 2, and 3 to the employee. The P45 shows their leaving date, total pay, and total tax for the year up to their leaving date. Report the leaving date on your next FPS. Don't issue a P45 until you've made the final payment. If the employee has outstanding holiday pay or a bonus due after their leaving date, you may need to process an additional pay run.
National Insurance Under PAYE
National Insurance contributions are collected alongside income tax through PAYE. Both employer and employee NI are calculated during each pay run.
| NI Category | Employee Rate | Employer Rate | Thresholds (2024-25 weekly) |
|---|---|---|---|
| Category A (standard) | 8% on GBP 242-GBP 967/week, 2% above | 13.8% above GBP 175/week | Primary: GBP 242, Secondary: GBP 175 |
| Category H (apprentice under 25) | 8% on GBP 242-GBP 967/week, 2% above | 0% up to GBP 967/week, 13.8% above | Employer relief up to upper earnings limit |
| Category M (under 21) | 8% on GBP 242-GBP 967/week, 2% above | 0% up to GBP 967/week, 13.8% above | Employer relief up to upper earnings limit |
| Category C (over state pension age) | 0% | 13.8% above GBP 175/week | No employee NI after state pension age |
PAYE Year-End Process
The UK tax year runs from April 6 to April 5. Year-end involves several mandatory steps that employers must complete by specific deadlines.
- Process the final pay run of the tax year (usually the April 5 pay period). Ensure all earnings, deductions, and statutory payments for the year are captured.
- Submit the final FPS of the year by April 19, marking it as the "final submission" for the tax year. This tells HMRC your payroll reporting for the year is complete.
- Issue P60s to every employee who was on your payroll on April 5. The P60 shows their total pay, tax, and NI for the full tax year. Deadline: May 31.
- Submit P11D forms to HMRC for any employees who received benefits in kind (company car, private medical insurance, interest-free loans, etc.) by July 6.
- Give employees a copy of their P11D by the same July 6 deadline so they can check the benefits reported.
- Pay any Class 1A NI on benefits in kind by July 22 (electronic) or July 19 (postal).
- Update your payroll software with the new tax year's rates, thresholds, and tax codes before running the first pay of the new year.
Frequently Asked Questions
Do all UK employers need to operate PAYE?
What's the difference between PAYE and Self Assessment?
Can HMRC collect underpaid tax through PAYE?
What happens if I use the wrong tax code for an employee?
Do I need to operate PAYE for directors?
How does PAYE work for employees with multiple jobs?
Written by Adithyan RK