1. PAYE (short for Pay As You Earn) is the method through which the UK tax authority, HMRC (HM Revenue and Customs) collects income tax via monthly payroll contributions.
2. The UK tax authority provides a personal allowance to eligible workers which is the amount that employees can earn in a year before having to pay tax.
3. The PAYE income tax collection process also includes an amount for national insurance to cover social care benefits and the NHS.
4. Using the IR35 Directive, the UK government has tightened restrictions around engaging contractors in off-payroll working to combat tax avoidance via ‘disguised employment’.
A recent article in the UK Guardian Newspaper highlighted the significant tax gap in the UK, which is the ‘difference between the expected income for the exchequer and actual receipts’. The shortfall for the 2020-2021 financial year stands at 5.1% equating to £32bn. HMRC has been somewhat unsuccessfully trying to reduce this tax gap for the last 6 years.
But now we seem to be coming out the other side of the pandemic, industry insiders are exerting pressure on the government to address the situation. The government’s very own findings suggest that there was “a very high chance that more households and businesses underpaid income tax and national insurance” during the pandemic.
What does this mean for international employers planning to or currently doing business in the UK? It’s likely that the UK HMRC may be entering a period of correction as it attempts to recoup losses in income tax and national insurance collection. So, employers should expect greater scrutiny around their tax filing affairs going forwards and need to be crystal clear on how PAYE is calculated.
What is PAYE?
PAYE (short for Pay As You Earn) is the method through which the UK tax authority, HMRC (HM Revenue and Customs) collects employee income tax via monthly payroll. The term PAYE is also used in Ireland, New Zealand and Nigeria, whereas in Australia it is referred to as PAYG (Pay As You Go). In the US it is generally referred to as Income Tax Withholding. Employers are responsible for collecting and filing income tax contributions with their respective government authority.
How is PAYE calculated?
PAYE is calculated and the amount paid is based on how much an employee earns during the pay period, which is typically 1 month in the UK.
The UK tax authority provides a personal allowance to eligible workers. This is the amount that employees can earn in a year before having to pay tax. For the 2022/23 tax year the personal allowance sits at £12,570 and this tax-free threshold changes regularly subject to annual inflationary pressures, prevailing government policy and the economic climate.
Once employees earn above the threshold, they are charged income tax at either 20%, 40% or 45% according to whether they are a basic rate, higher rate or additional rate taxpayer. The employee’s tax rate band/classification is based on their income.
How is PAYE calculated in the UK?
The PAYE tax rates and PAYE income limits for 2022-23 are shown below, and you can always find the latest income tax rates at the UK Inland Revenue web portal.
Up to £12,570
£12,571 to £50,270
£50,271 to £150,000
HMRC also provides a useful tool with its PAYE payment calculator.
Tax is deducted at source by the employer based on the figures in this table each time an employee is paid, typically monthly in the UK. PAYE is therefore generally divided into equal payments over the course of the year and employees receive a refund if they have paid too much, which is normally reimbursed through the payroll by the employer. If the employee has paid too little tax for whatever reason, they will receive a bill requiring them to pay more.
National Insurance (NI)
The PAYE income tax collection process also includes an amount for National Insurance (NI) to cover social care benefits and the NHS.
Most workers pay class one NI contributions and employers will need to deduct at the following rates: For 2022 to 2023 there is a 13.25% standard NI deduction increasing to 16.5% for those earning over £4,189 a month. This represents an increase of 1.25% from the previous year as a result of the new Social Care Levy to help fund new health and social care as a result of the pandemic and the ageing population. Employers are also required to make a secondary contribution, (Employers NI), at 15.05% for the 2022/2023 tax year.
Off-payroll – How Is PAYE Calculated?
Using the IR35 Directive, the UK government has tightened restrictions around engaging contractors in off-payroll working to combat tax avoidance via ‘disguised employment’. This tax avoidance occurs when employees are incorrectly classified as contractors, which means that contractors and their clients pay less tax and NI Contributions. Medium to large employers in the UK are directly responsible for correctly classifying workers under IR35 and fines of 30% of unpaid tax are issued if they get this process wrong. However, if HMRC finds that an employer knowingly contravened IR35, a fine of 70% of unpaid tax is incurred. IR35 employment classification is a complicated process and for this reason, the UK government has developed an online employment status checker that employers can use to ensure that independent contractors are paid correctly.
What is the penalty for failing to comply with PAYE?
Employers must pay their PAYE bills to HMRC according to specific schedules and procedures which can be found here. Employers who fail to make the appropriate PAYE deductions and file them with HMRC in full and on time will receive a late payment penalty. The first time that any employer does not pay their PAYE on time is not considered a default, but any future late payments will result in a penalty percentage being applied to the overdue amount for that month.
Number of defaults in a tax year
1 to 3
4 to 6
7 to 9
10 or more
HMRC video: When and how to calculate PAYE
In the video below, the UK tax authority (HMRC) explains how PAYE is to be calculated in the UK.
If the employer fails to pay monthly or quarterly PAYE deductions in full to HMRC after 3 months, they will be charged an additional late filing penalty of 5% of the outstanding amount. If full payment has not been made after 12 months than an additional 5% penalty is applied to the remaining outstanding amount.
Horizons calculates and processes PAYE for UK employees
As you can see PAYE is complex process, (particularly in the UK with its IR35 directive) and if you need help correctly paying employees in the UK jurisdiction then please contact us at Horizons who can ensure payment of PAYE and manage UK payroll on your behalf.
Frequently Asked Questions (FAQ)
The UK tax authority providers a personal allowance to eligible workers. This is the amount that employees can earn in a year before having to pay tax. For the 2022/23 tax year the personal allowance sits at £12,570. Once employees earn above the threshold, they are charged income tax at either 20%, 40% or 45% according to whether they are a basic rate, higher rate or additional rate tax payer.
However, it is possible to pay independent contractors amounts on regular intervals that are equivalent to a salary or wages in monetary terms.
The PAYE tax rates and thresholds for 2022-23 are shown below, and you can always find the latest income tax rates at the UK Inland Revenue web portal.