What Is PAYE? A Complete Guide for UK Employers

PAYE (Pay As You Earn) is the system HMRC uses to collect Income Tax and National Insurance contributions (NICs) from employees' wages before they are paid.[1] Rather than workers settling their full tax liability at year-end, PAYE ensures deductions happen at source on every pay run. The ONS estimates that 30.3 million people in the UK are paid through the PAYE system,[2] making it the backbone of UK income tax collection. For employers, operating PAYE correctly is a legal obligation: failure can result in automatic penalties, back-tax demands, and enforcement action from HMRC. Moonworkers' payroll software is built around PAYE compliance, automating calculations, tax code updates, and RTI submissions so employers can pay staff accurately on every pay run.

How PAYE Works: Deductions at Source

Under PAYE, every employer calculates the correct amount of Income Tax and National Insurance to deduct from each employee's gross pay before issuing their net wage.[1] The calculation is driven by the employee's tax code, which HMRC issues based on individual circumstances, most commonly the entitlement to the personal allowance. Employers are responsible for applying the correct code and remitting the resulting deductions to HMRC on a monthly or quarterly basis.

Income Tax Deductions

Income Tax is calculated progressively above the standard personal allowance of £12,570 per year.[3] Earnings between the personal allowance and £50,270 attract the basic rate of 20%; earnings between £50,271 and £125,140 attract the higher rate of 40%; and any earnings above £125,140 are taxed at the additional rate of 45%.[3] These rates are applied cumulatively within each tax year so that the correct total deduction is spread evenly across all pay periods.

Every employee must receive a payslip showing their gross pay, each deduction itemised, and their net pay. PAYE also covers Statutory Sick Pay (SSP), Statutory Maternity Pay (SMP), and other statutory payments that employers administer and may recover through their PAYE account.

National Insurance Contributions

National Insurance operates alongside Income Tax but follows separate thresholds. For the 2025 to 2026 tax year, the Lower Earnings Limit (LEL) stands at £125 per week (£542 per month).[4] Once earnings reach the LEL, an employee's NI record is credited even though no employee NICs are due until the Primary Threshold (PT) of £242 per week (£1,048 per month) is reached. Above the PT, employee Class 1 NICs are charged at 8%.[5]

Employer Class 1 NICs apply above the Secondary Threshold (ST), which was reduced to £96 per week (£417 per month, £5,000 per year) from April 2025 as part of the Autumn Budget 2024 changes.[4] The employer NIC rate also increased from 13.8% to 15% from the same date, meaning employers now pay NICs on a substantially larger portion of each employee's wage than in previous years. To offset part of this cost for smaller employers, the Employment Allowance was increased to £10,500 per year from April 2025, with the previous £100,000 liability cap removed.[6]

Who Must Register for PAYE?

An employer is legally required to register for PAYE with HMRC before making the first payment to any employee.[7] Registration is triggered when a new hire earns above the LEL (currently £125 per week), when an employee has a second job, when an employee receives a pension alongside their wage, or when the employer provides taxable benefits in kind.

Self-employed individuals operating as sole traders fall outside PAYE and settle their tax liability through Self Assessment instead. However, a director of a limited company who pays themselves a salary must register for and operate PAYE, even if that salary falls below the personal allowance.[7] The obligation arises from the act of making a payment through payroll, not from a tax liability existing on that payment.

Registering as an Employer

Registration is completed online through HMRC's employer registration service.[7] HMRC issues a PAYE reference and Accounts Office reference, both of which are required on every RTI submission and payment. There is a minimum processing time of approximately 15 working days before a new employer reference is issued, so registration should begin well in advance of the first pay date. New employers will not be penalised for late RTI filing during the 30 days immediately following their first required submission,[8] but this concession does not extend beyond that initial period.

Understanding Tax Codes Under PAYE

A tax code tells the employer how much tax-free income an employee is entitled to in the current tax year. The most common code is 1257L, reflecting the standard personal allowance of £12,570 per year: the number represents the allowance divided by ten, and the suffix describes how Income Tax should be applied.[9]

Letter Suffixes Explained

The letter component of a tax code carries a specific meaning that determines how the employer calculates Income Tax deductions.[10]L is the standard personal allowance code used by the majority of employees. M and N indicate a Marriage Allowance transfer: M confirms the employee has received a 10% allowance transfer from their spouse or civil partner, while N shows they have transferred 10% of their allowance away. BR means all earnings are taxed at the basic rate (20%), typically applied to secondary employments where no personal allowance is available. K codes arise when an employee has untaxed income or a benefit in kind that exceeds their personal allowance, resulting in a deduction added to gross pay before tax is calculated.

Employers receive tax code notifications from HMRC via a P6 coding notice or through the PAYE desktop service. Failure to apply the correct code can result in the employee being over or under-taxed, with HMRC potentially raising a compliance enquiry against the employer.[11]Moonworkers' payroll API ingests HMRC tax code updates automatically and applies them from the correct effective date, eliminating the risk of processing payroll on a superseded code.

Emergency Tax Codes

When a new starter does not provide a P45 from their previous employer, the employer must apply an emergency tax code.[12] The emergency code is 1257L applied on a Week 1 or Month 1 basis (indicated by the suffix W1, M1, or X), meaning tax is calculated on each period's earnings in isolation rather than cumulatively. This prevents any personal allowance from one period being carried forward to offset tax in another.

HMRC can take up to 35 working days from the employee's start date to issue a full tax code via the PAYE coding service.[12] In the interim, the employer uses the emergency basis. Where the correct code results in a lower tax liability than the emergency code produced, HMRC will refund the overpayment directly to the employee once the cumulative calculation resumes. Employers must not continue using the emergency basis after receiving a formal code notification from HMRC.

Real Time Information (RTI) and Reporting Obligations

Since April 2013, all UK employers have been required to report payroll data to HMRC under Real Time Information (RTI).[13] Under RTI, submissions must be made on or before each payday, not at the end of the month. This gives HMRC a near-real-time picture of the UK workforce and allows cross-checking of Universal Credit, tax credits, and other benefit claims against actual earnings.

Full Payment Submission (FPS)

The Full Payment Submission (FPS) is the primary RTI return. It must be submitted on or before each payday and contains details of every employee paid in the period: gross earnings, Income Tax deducted, employee NICs, employer NICs, and year-to-date cumulative figures.[14] A limited three-day filing concession exists for micro-employers who genuinely cannot submit on payday, but this does not apply to all employers and should not be treated as the default position.

The FPS also carries the employee's new starter declaration if they are joining the payroll for the first time. If no P45 is available, the employer completes a starter checklist to determine which statement (A, B, or C) applies and codes the employee accordingly until HMRC issues a formal P6 notice.[14]

Employer Payment Summary (EPS)

An Employer Payment Summary (EPS) is submitted when the employer needs to adjust the amount owed to HMRC for the tax month.[15] The EPS is used to claim the Employment Allowance, to recover Statutory Maternity Pay and other statutory payments, or to notify HMRC that no employees were paid in a given month (a "nil payment" EPS). Failure to submit an EPS when recovery is due will result in HMRC collecting the full liability without offset.

Late Filing Penalties

HMRC issues automatic late filing penalties based on the number of employees on the payroll, charged on a monthly basis where any RTI return is filed late.[8] The current fixed penalty amounts are: £100 per month for schemes with 1 to 9 employees; £200 per month for 10 to 49 employees; £300 per month for 50 to 249 employees; and £400 per month for 250 or more employees. An un-penalised default is allowed once per tax year (the first late filing in a given scheme year does not attract a penalty), but every subsequent late month does.[8] A further penalty equal to 5% of the tax or NICs that should have been reported is applied when the failure continues beyond three months. Since April 2024, HMRC has applied these penalties consistently with no further concession periods.

PAYE Payment Deadlines and Key Thresholds

Once deductions are calculated, the employer must remit the combined Income Tax and NICs to HMRC. The deadline depends on the payment method, and clearance at HMRC's account (not despatch) is what counts.[16]

Sources: HMRC rates and thresholds for employers 2025 to 2026.[4][3][5]

P60, P45, and End-of-Year Obligations

Beyond the monthly RTI cycle, PAYE imposes several annual obligations that require specific documents to be issued or filed on time.

P60: Annual Summary for Employees

A P60 summarises the employee's total pay, Income Tax, and NICs for the full tax year. It must be issued to every employee who remains on the payroll at the end of the tax year, with a statutory deadline of 31 May following the tax year end.[17] Employees use the P60 to complete Self Assessment returns, claim tax repayments, or verify their NI record. Failure to provide a P60 by the deadline is a PAYE compliance breach and HMRC may require the employer to demonstrate the document was issued.[17]

P45: Leaving Documentation

When an employee leaves, the employer must issue a P45 recording the employee's earnings and tax deductions up to the leaving date, the total year-to-date figures, and their tax code at the point of departure.[18] The P45 is passed to the next employer to ensure the departing employee is placed on the correct tax code from their first pay date. Without a P45, the new employer must apply an emergency code, which frequently leads to over-deduction of tax in the initial weeks of the new employment. The cessation must also be reported to HMRC via the employee's final FPS submission.[18]

Benefits in Kind: P11D and Mandatory Payrolling

Where employers provide taxable benefits in kind (such as company cars, private medical insurance, or interest-free loans) and do not payroll them, these must be reported to HMRC on a P11D form for each affected employee. The P11D submission deadline is 6 July following the end of the tax year, with a separate P11D(b) required to declare and pay the Class 1A NIC liability on those benefits.[19] Late P11D submissions attract automatic penalties.

Employers may instead choose to payroll benefits in kind, reporting the cash equivalent through the payroll and deducting tax in real time rather than via a year-end return.[20] HMRC has confirmed that payrolling of benefits in kind will become mandatory from April 2026, meaning all employers will need compliant payroll software capable of processing taxable benefits through RTI by that date.[21] Employers who have not yet registered for voluntary payrolling should do so before the start of the relevant tax year. Moonworkers' payroll software already handles payrolled benefits in kind, ensuring employers are ready for the April 2026 mandate.

Conclusion

PAYE is the mechanism through which UK employers collect and remit Income Tax and National Insurance on behalf of their entire workforce. Operating it correctly requires accurate tax code management, timely FPS and EPS submissions under RTI, precise threshold calculations on every pay run, and adherence to year-end obligations including P60s, P45s, and benefits reporting. The April 2025 changes to employer NIC rates (from 13.8% to 15%) and the reduced Secondary Threshold (from £175 to £96 per week) have increased the complexity and cost of payroll for many businesses, making robust, up-to-date software more important than ever. Moonworkers' HMRC-recognised payroll software handles PAYE calculations, RTI submissions, and P60 generation automatically, removing the manual burden for employers. For developers integrating payroll into HR or ERP platforms, Moonworkers' payroll API delivers the same compliance engine through a modern, well-documented interface.

Frequently Asked Questions

What does PAYE stand for?PAYE stands for Pay As You Earn. It is the HMRC system used by UK employers to deduct Income Tax and National Insurance contributions from employees' wages at source before net pay is issued. Approximately 30.3 million people in the UK are paid through PAYE. The employer then remits those deductions to HMRC on a monthly or quarterly basis.

When must an employer register for PAYE?UK employers must register for PAYE with HMRC before making the first payment to any employee who earns above the Lower Earnings Limit (currently £125 per week). Registration is also required if the employee has a second job, receives a pension, or benefits from taxable expenses or benefits in kind. Directors of limited companies who pay themselves a salary must operate PAYE even if that salary is below the personal allowance.

What is an FPS in PAYE?An FPS (Full Payment Submission) is the RTI return employers must send to HMRC on or before each payday. It contains each employee's gross pay, Income Tax deducted, and National Insurance figures for the period. Missing the FPS deadline triggers automatic late filing penalties from HMRC: £100 per month for schemes with 1 to 9 employees, rising to £400 per month for 250 or more employees.

What changed with employer National Insurance in April 2025?From April 2025, the employer National Insurance rate increased from 13.8% to 15%, and the Secondary Threshold (the point at which employer NICs become due) was reduced from £175 per week to £96 per week. Both changes were announced in the Autumn Budget 2024. To offset part of this increase, the Employment Allowance was raised from £5,000 to £10,500 per year, with the previous £100,000 liability cap removed.

What is the deadline for paying PAYE to HMRC?Employers paying electronically must ensure HMRC receives the combined Income Tax and National Insurance by the 22nd of the month following the tax month. Those paying by cheque or post must send payment by the 19th. The payment must clear HMRC's account by the deadline, not merely be despatched. Late payment incurs interest and potential surcharges. Moonworkers' payroll software calculates the liability automatically and shows the exact amount due to HMRC each month.