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Operating payroll

All businesses that pay or will be paying staff in the future need to operate a payroll system. Here are the facts you need to know about setting up and operating payroll.

What is payroll?

Payroll is the payments a business makes to staff (including directors) during a week or month. As well as salaries and wages, payments to staff may include:

  • tips
  • bonuses
  • overtime 
  • expenses
  • benefits in kind (for example the use of a vehicle or health care).

There may be additional payments for:

  • holiday
  • sickness
  • maternity
  • paternity
  • adoption
  • shared parental leave.

PAYE (Pay As You Earn) is the HMRC (HM Revenue and Customs) system which is used by businesses to report information about staff and to collect both income tax and national insurance from employment.

Do I need to register for PAYE?

Most businesses will need to register as an employer under PAYE when they start to pay staff.

To find out if you are required to register take a look at the questions below.

  1. Are any employees paid £123 per week or more?
  2. Do any employees have another job?
  3. Do any employees receive a pension?
  4. Do any employees receive expenses or benefits?
  5. Will you be using subcontractors under the Construction Industry Scheme (CIS)? NB. This question is only relevant to employers in the building or construction trade.

If yes has been selected for any of the five questions listed above you must register for PAYE.

  • Registration must be completed before the first pay day.
  • You can register as an employer with HMRC online.
  • HMRC will send you a PAYE reference (for example 123/AB456) and an accounts office reference (which is 13 characters long, for example123PA00123456) usually within five working days.

You will also need to register for payroll online to report information about staff to HMRC.

What details do I need about my staff?

When a new employee joins a business the following information will be required and must be reported to HMRC:

InformationDetailWhere can I get the information?
1. Personal detailsName, address, gender, date of birthP45 or starter checklist
2. National insurance numberA unique number issued to all UK residenrs over the age of 16P45 or starter checklist
3. Start dateThe date this employment startedOffer letter or contract of employment
4. Tax codeThis determines the amount of income tax which needs to be deducted from the employee.P45 or starter checklist (*) or PAYE coding notice (P9T) issued by HMRC
5. National insurance categoryThis determines the amount of national insurance which needs to be deducted from the employee and any amounts payable by the employer (the most common being A (under state pension age) and M (under 21)A full list of national insurance categories can be found on GOV.UK.
6. Student loanAny amounts outstanding before the last 6 April from a course of UK higher educationP45 or starter checklist or Student Loan Start Notice (SL1) issued by HMRC
7. Normal weekly hours workedYou will need to select from the following: less than 16, 16 to 24, 24 to 30, 30 or more, otherOffer letter or contract of employment
8. Payment How frequently the employee will be paid: weekly, two weekly, four weekly, monthly, quarterly, biannual, annualOffer letter of contract of employment

If the employee has previously been employed a form called a P45 will have been issued by the previous employer. For employees without a P45 the starter checklist can be used.

 * Within the starter checklist the employee must select one of the following statements:

  1. This is my first job since last 6 April and I have not been receiving taxable Jobseeker’s Allowance, Employment and Support Allowance, taxable Incapacity Benefit, State or Occupational Pension
  2. This is now my only job but since last 6 April I have had another job, or received taxable Jobseeker’s Allowance, Employment and Support Allowance or taxable Incapacity Benefit. I do not receive a State or Occupational Pension.
  3. As well as my new job, I have another job or receive a State or Occupational Pension.

 Your payroll software or provider will tell you the tax code to use based on the statement which has been selected.

The amount that a business decides to pay its employees and the amount that the employee actually receives will usually be different. This can be calculated using the formula:

Gross pay – deductions = net pay

The amount that a business decides to pay its employees and the amount that the employee actually receives will usually be different. This can be calculated using the formula:

Gross pay - deductions = net pay

Gross pay

Gross pay is the total amount an employee has earned for a pay period. The amount of gross pay an employee will receive will depend on several factors.

These factors are:

  • Are they paid based on time, for example hourly, weekly or monthly?
  • Are they paid based on output or performance?
  • Have they worked any overtime or unsociable hours?
  • Are they entitled to any bonuses or commission?
  • Are they entitled to any additional payments, for example holiday, sickness, maternity, paternity etc?

Minus Deductions

Deductions are any amounts which are taken from an employee’s gross pay before the employee receives it.

  • Income tax – payable to the government on the amounts an individual earns
  • National insurance contributions – paid by both employees and employers towards certain state benefits
  • Student loans – the repayment of amounts outstanding from a course of UK higher education
  • Pension contributions – the amount payable by the employee under an occupational pension scheme
  • Payroll giving – this allows employees to give to a charity
  • Other deductions – this may include loan repayments, union subscriptions, court orders (known as attachment of earnings) and maintenance payments.

Equals Net Pay

Net pay is the difference between gross pay and deductions and is the amount which is paid to the employee.

An employer may choose to pay the employee by cash, bank transfer or cheque.

The employer must provide the employee with a record of pay which shows the gross pay, deductions and net pay.

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Video: How do I calculate payroll deductions?

by Informi

In order to calculate payroll deductions you must decide whether you are going to operate the payroll system yourself or appoint someone to do it for you. A payroll bureau or accountancy firm can operate your payroll system for you at a cost.

There are advantages of asking your accountant to manage your payroll. The additional cost is likely to be low and it’s a real time saver each month. 

If you choose to run your own payroll system you will need to decide which software to install:

  • HMRC offer free payroll software called “Basic PAYE Tools” which can be used for businesses with up to 10 employees
  • There is other payroll software available on the market. However, HMRC cannot recommend one software product or service over another and is not responsible for any problems you have with software that you have bought.

Your payroll provider or software will be able to calculate the statutory deductions (income tax and national insurance contributions) you need to deduct from your employees.

The GOV.UK website also provides calculators and tax tables should you want to manually check your payroll calculations. 

How does PAYE work for employers? Watch the video below to find out more on how PAYE is accrued and paid. The video also demonstrates the concept of an employee’s personal allowance and tax code.

Do I need to issue my staff with anything?

There are certain documents that must be issued to employees:

Payslips

For every pay period employees must be supplied with a record of pay (either paper or electronically). This should show the gross pay, employee’s national insurance contributions, income tax, other deductions, net pay and how the net pay is paid.

P45

P45s are issued to employees who leave your employment during the tax year. They show the employee’s year to date gross income and the year to date tax paid.

P60

P60s are issued to employees who are still in your employment at the end of the tax year. They show the employee’s gross income for the year and the tax paid for the year. The forms must be provided to the employee by 31 May following the end of the tax year.

P11D

If any employees receive benefits in kind, for example, the use of a vehicle or health care, the employer must send a P11D to HMRC. This records how much each benefit is worth. Employees must be notified about what the P11D contains.
Payslips

For every pay period employees must be supplied with a record of pay (either paper or electronically). This should show the gross pay, employee’s national insurance contributions, income tax, other deductions, net pay and how the net pay is paid.

P45

P45s are issued to employees who leave your employment during the tax year. They show the employee’s year to date gross income and the year to date tax paid.

P60

P60s are issued to employees who are still in your employment at the end of the tax year. They show the employee’s gross income for the year and the tax paid for the year. The forms must be provided to the employee by 31 May following the end of the tax year.

P11D

If any employees receive benefits in kind, for example, the use of a vehicle or health care, the employer must send a P11D to HMRC. This records how much each benefit is worth. Employees must be notified about what the P11D contains.

Checklist: Do I need to keep payroll records?

It is the responsibility of the business to keep payroll records (even if an external accountant or bureau manages your payroll). Failure to keep payroll records could result in HMRC issuing a penalty of up to £3,000; payroll records must be kept for three years following the end of the tax year to which they relate. There are various payroll records you keep for each tax year. Use this handy checklist to ensure you have the relevant paperwork and documents stored in your files. Login to save this checklist to your profile for future use - as you work through the list, any checkboxes that are ticked or unticked will be automatically saved to your profile. (To register to join and enjoy the benefits of membership click on the link at the top right of the page. It will only take a few minutes to create your profile).

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