PAYE

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An outline of Pay As You Earn.

All payments to employees including "casuals", "pensioners", "part-timers" are subject the PAYE and NIC rules. Some employees may not be liable to pay PAYE or NIC, but the employer still needs to keep records showing that potential deductions were considered.

PAYE applies to all employees including directors receiving income arising from employment. It may not be applied to some expense payments or benefits in kind.

The Inland Revenue issue a code number such as 522L1. Most codes comprise three parts - a code number (522), a code letter (L) and a code method (1).

Code letters have the following meanings (in alphabetical order) -

BR - Basic Rate at 22% (allowances are probably given against another source of income).
D - Higher rate taxpayer (code D0 is 40%, D1 used to be 45% etc.)
K - Employee has benefits or other income exceeding personal allowances.
L - Basic Personal Allowance (used to be single person or married woman whose husband claimed married allowance and under 65).
NT - No tax (source of income probably included in Self Employed accounts).
OT - Zero pay adjustment but 10%, 22% and 40% tax bands are applied (allowances are probably given against another source of income).
P - Personal Allowance for those age 65 to 74 (used to be single person or married woman whose husband claims married allowance in that age group).
T - Tax office will notify any code changes (typically a second job or taxpayer has asked that suffix not be notified to employer).
V - Personal Allowance and Married Couples Allowance for those aged 65 to 74.
Y - Personal Allowance for those over 75.

Code number is normally a person's tax allowances divided by 10. Someone with the basic personal allowance of £5,225 would have a code of 522.

The effect of most codes is to exempt some income from tax. 522L equates to £435 per month free of tax. K codes have the opposite effect and add to income. Code 120K adds £100 per month to income subject to tax with an overriding limit of tax at 50% of the current payment.

Code method is either "1" or blank. "1" equates to treating each pay period separately, commonly known as week 1 basis or month 1 basis. Tax deductions are calculated on a cumulative basis for the tax year ending 5 April unless week/month 1 basis applies. Week/month 1 basis is normally applied when there has been an under deduction of tax. It prevents the PAYE tables from recovering the whole underpayment in one period by granting some allowances in each period, but unused allowances in any period are not carried forward.

The employer receives a notice of coding showing the tax code (e.g. 522L1). Sometimes this will show pay and tax from a previous employment for the tax year to date. The employee also receives a notice showing the tax code and detailing how it has been calculated.

When an employee leaves, the employer will complete a form P45 and send part 1 direct to the Tax Office. The other parts are handed to the employee who retains part 1a permanently but hands parts 2 and 3 to his/her next employer or benefit office. The new employer retains part 2 and completes part 3 before sending that part to the new employers Tax Office.

Employees in employment at 5 April each year receive a form P60 summarising their income, NI and tax for the year. This is the third part of combined form P14/P60 completed by the employer. The top part of form P14 is the Contributions Agency record of pay and NI contributions, the second part of that form is the Tax Office record of pay and tax.

PAYE income tax (and NI contributions) are remitted by employers to the Inland Revenue by the 19th of each month following deduction, although small employers can remit quarterly.

Reminder - disclaimer applies. Please feedback your comments. This page was last modified 17 May 2007.