April 2024

Understanding the UK's payroll compliance

What employers need to know

Introduction to payroll in the UK

Understanding the payroll system is crucial for every business, self employed and charity in the UK. Not only is it a legal obligation, but proper payroll management ensures that employees are paid correctly and on time, in compliance with the UK tax and employment regulations provided by His Majesty Revenue and Customs (HMRC). This article seeks to shed light on the basic knowledge required to manage payroll effectively in the UK, ensuring compliance and accurate compensation for all employees. Whether you're a small business owner, a charity treasurer, or just curious about the payroll process, this guide will provide a foundational understanding of the UK's payroll practices.

What is payroll? Obligations of an employer

Payroll is the process by which employers calculate and distribute wages and salaries to employees, which includes the deduction of relevant taxes (such as Income Tax and National Insurance contributions) and any other deductions (like pension contributions, student loan repayments, etc.). As an employer, you shoulder the responsibility of deducting the right amount of tax and other contributions from your employees' wages. It's crucial to understand the consequences of delayed reporting. Not only does late reporting attract penalties, but it can also have an adverse impact on employee benefits. The repercussions are both financial and administrative, underscoring the necessity for punctuality. Additionally, it is crucial for businesses to retain payroll reports for a minimum duration of three years.

Understanding the PAYE system

What is PAYE?

The PAYE (Pay As You Earn) system is the means by which HMRC collects Income Tax and National Insurance Contributions from employees’ salaries. Employers must adhere to a PAYE payroll cycle that runs from the 6th of one month to the 5th of the following month.

Employers are responsible for calculating and deducting the correct amounts from each employee's pay, generation of payslips, and timely reports to the HMRC. Employers must maintain accurate records of employee pay, deductions, and taxes. They also need to report payroll information to HMRC through Real Time Information (RTI), which provides up-to-date tax and National Insurance information.

How PAYE works?

Employers deduct tax and National Insurance contributions before paying wages or pensions to employees. The amounts are sent directly to HMRC. Initiating PAYE system requires several steps:

  • Registration as an employer:

    Before you set up the payroll, you must officially register your business as an employer.

  • Full Payment Submission (FPS):

    The mechanism for registering employees' pay and deductions. For the first one you will need their P45 and some basic details: name, address, date of birth, tax code, student loan information.

  • Setting up PAYE:

    system like Liberty Accounts will ensure compliance with HMRC, laying the foundation for efficient wage and tax administration.

Monthly tasks in the PAYE cycle

Every tax month—beginning on the 6th and ending on the 5th of the subsequent month—is punctuated by a set of tasks that demand the attention of employers operating PAYE.

  • 10th - you can view what you owe from your FPS
  • 19th - by 19th of every month send an Employer Payment Summary (EPS) to claim any reductions on what you’ll owe HMRC. You will see the balance of what you owe updated within 2 days of sending the EPS
  • 19th - if paying by post, send the payment by 19th
  • 22nd - Pay HMRC by 22nd. Late payment penalties are applicable.
Year-End reporting

At the end of the tax year (April 5th), employers need to provide employees with a P60 form detailing their total earnings and deductions for the year. Employers also submit a report called a P11D to HMRC detailing any expenses, benefits, or perks provided to employees.

Employee tax codes and their significance

Codes, made of letters and numbers, indicate a taxpayer situation that affects personal allowance, the tax-free amount an individual is entitled to in a tax year. Correct codes ensure the right amount of tax is taken.

National Insurance Contributions

National Insurance Contributions (NICs) are taxes paid in the UK by employees, employers, and the self-employed to support various government benefits. NICs are deducted from payrolls and depend on factors like age, earnings, and employment status. They fund social programs, such as pensions, unemployment, and sickness benefits. NICs are crucial for eligibility to benefits and the State Pension in the UK.

    There are several classes of NICs:
  • Class 1 NICs cover employment income, with rates, thresholds, and reliefs for employees and employers.
  • Class 2 NICs apply to self-employed individuals with a flat weekly rate.
  • Class 3 NICs are voluntary contributions designed to fill gaps in National Insurance records and boost the State Pension.
  • Class 4 NICs apply to self-employed individuals with profits above a certain threshold, involving a tiered contribution system.

The National Insurance system was introduced with the 1911 National Insurance Act, and the National Insurance number uniquely identifies individuals for contributions and social security purposes. NICs start at age 16, with a set income threshold, and apply to earnings rather than investments.

To be eligible for the full new State Pension, individuals need at least 35 qualifying years of NICs. Voluntary contributions can be made to enhance future pensions and fill gaps in National Insurance records.

NICs are a vital part of the UK's social security system, ensuring that individuals have access to benefits during times of need, such as unemployment, illness, retirement, or bereavement.

Real Time Information (RTI) in payroll

Real Time Information (RTI) is a system used in payroll in which employers report their PAYE (Pay As You Earn) information to HMRC (Her Majesty's Revenue and Customs) in real-time, typically electronically. This process is designed to be more accurate and up-to-date compared to traditional payroll systems.

There are several key submissions within the RTI system:

Full Payment Submission (FPS):

This is the main RTI submission made by employers to HMRC, detailing payments and deductions made to employees. The FPS is submitted for each pay period and includes details like tax, National Insurance contributions, deductions, and payments. This replaces the need for end-of-year submissions such as the P35 form.

Employer Payment Summary (EPS):

This reports any deductions that are taken from the FPS data, including recoverable statutory payments, NIC holiday, and CIS deductions. If no payment is due to HMRC, a Nil EPS is submitted to avoid penalties. The deadline for sending EPS is by the 19th of the following tax month. HMRC will apply any reduction on what you’ll owe from your FPS. Once you’ve sent EPS you will be able to see within 2 days what you’ve claimed and the balance of what you owe either on your HMRC online account or in Liberty Accounts software.

Earlier Year Update (EYU):

This was used for making adjustments to the end-of-year records, but it is no longer valid from 2020-2021 onwards. Instead, corrections are made through revised FPS or year-to-date FPS submissions.

Employee Alignment Submission (EAS):

Used by large employers to align employee data with HMRC.

RTI has brought several changes to the payroll system, such as replacing P45/P46 forms with starter questions and a Starter Checklist for tax codes. RTI requires the use of software, and employers need to keep current employee details, collect new employees' passport numbers, and gather payroll info beforehand to avoid errors. Penalties are in place for failure, late filing, or wrong submissions in the RTI system.

Statutory payments

Statutory payments refer to payments that are mandated by law and must be provided by employers to their employees under certain circumstances. The most common statutory payments include Statutory Sick Pay (SSP), Statutory Maternity Pay (SMP), Statutory Paternity Pay (SPP), and Statutory Adoption Pay (SAP). These payments are designed to provide financial support to employees during periods of sickness, childbirth, or adoption.

For example, Statutory Maternity Pay (SMP) is paid for up to 39 weeks: the first six at 90% of average gross weekly earnings and the remaining 33 at either the standard rate or 90% of earnings. Eligibility for SMP is determined by average weekly gross earnings over a specific period. The lower earnings limit (LEL) is crucial for eligibility. Earnings are calculated over eight weeks leading to the qualifying week, which is the 15th week before the due date. Bonuses, sick pay, holiday pay count, and pay rise during calculation affects SMP. Salary sacrifice and student bursaries impact calculations. SMP is taxed, treated as earnings, and paid like regular wages. Qualifying for SMP doesn't affect other maternity payments and it's not repayable if not returning to work.

Special Severance Payments are another type of statutory payments that go beyond legal obligations and need strong taxpayer interest. These payments can cover legal proceedings, benefits, loans, retraining, and more. Some in lieu of notice or pension strain may qualify.

There are recoverable benefits based on National Insurance payments, such as Statutory Sick Pay that provides £94.25 per week for up to 28 weeks

Employers need to understand statutory payments like sick pay or maternity pay, which are processed through payroll.

Choosing the right UK payroll software

Selecting the right payroll software for your UK business involves careful consideration of several factors to ensure accurate, timely, and compliant payroll management. Automation in payroll processing is crucial as it simplifies payroll tasks, reduces errors, and ensures compliance. With the help of automated payroll software, employers can easily record intricate employee pay details, perform calculations regarding employee deductions, and determine the precise employer's National Insurance amount. Payslips can be generated for the workforce, and pay details and deductions can be reported to HMRC through the Full Payment Submission (FPS) protocol.

When selecting payroll software, look for features such as automatic updates, RTI compatibility, data security, and easy integration with HMRC. Payroll software should also be user-friendly, easily configurable, and offer cloud-based access for convenience and flexibility. It should maintain organised pay records for compliance and audits, including employee data, and adapt to regulatory changes to simplify tax compliance.

It is also important to consider the pricing and scalability of payroll software, especially for small businesses. Assess your business size and needs, and evaluate Liberty Accounts software. It adheres to Real-Time Information (RTI) reporting to HMRC and includes essential functionalities like employee data recording, statutory pay computation, pension scheme integration, real-time HMRC reporting, and precise payment calculations. Online payroll software like Liberty Accounts offers robust solutions tailored for UK businesses, charities, churches, and other not-for-profit organisations. Our software can automate all calculations and is regularly updated according to the latest government requirements. It generates payslips, files necessary reports directly to HMRC, and integrates payroll with accounting software to ensure consistency between financial records and payroll. Automation reduces human errors, ensures prompt employee payment, and saves time.

Conclusion: Streamlining UK payroll

In conclusion, payroll management is a challenging but crucial task that encompasses several key responsibilities, including accurate calculations, timely payment of salaries, compliance with tax and employment regulations, and appropriate record-keeping. Whether you are an employer or self-employed, understanding the UK payroll system is imperative to avoid legal and financial complications. The PAYE system, National Insurance Contributions, Real Time Information, statutory payments, and the importance of online payroll software are all vital components of effective payroll management. By staying informed about these aspects and implementing an efficient payroll system, employers can ensure smooth operations, compliance with HMRC requirements, and a positive work environment for their employees. By choosing reliable online accounting and payroll software like Liberty Accounts, UK businesses can automate the process, ensuring accuracy, timeliness, and compliance, which ultimately benefits both employers and employees.

Register for a free trial of Liberty Accounts to see how much time you will save.

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