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PAYE, or Pay As You Earn, is the payroll system used in the United Kingdom to collect income tax from employees who earn a salary. In this blog post, we will discuss PAYE in detail and explain how it is calculated. We will also cover tax-free personal allowances, national insurance, tax rates, and tax thresholds. So if you want to know everything about PAYE, keep reading!

What is PAYE and how is it calculated

PAYE is a system of UK taxation that requires employers and pension providers to deduct income tax and national insurance contributions from their employees’ salaries. The deductions are then paid to HM Revenue & Customs (HMRC) on the employee’s behalf.

How is PAYE calculated in the UK?

The PAYE calculation is based on how much an employee earns during a pay period which is often monthly in the UK, but some employees are paid weekly.

What is a personal allowance?


Everyone has a personal allowance for income tax each tax year. The UK tax year starts on 6th April and finishes on 5th April 12 months later. In the 2022 /23 tax year the personal allowance is £12,570. The personal allowance is the tax-free amount that employees or those in receipt of their pension, can earn per tax year before having to pay any income tax. The threshold is reviewed annually and adjusted by the UK government to ensure the tax threshold system remains fair and reflects increases with inflation.

Your personal allowance may not be £12,570 as it is affected by your tax code which is explained more fully in our ‘What is your tax code and what does it mean?’

Taxable income is taxed at what rate?


If employees earn more than the personal allowance, their earnings above the personal allowance threshold are subject to income tax at either 20%, 40% or 45%. The tax rate increases as earning thresholds are reached, and the next band of taxable income is taxed at a higher rate. The current 2022 to 2023 income tax rates and taxable income bands are:

Band Income Tax Rate
Personal Allowance Up to £12,570 0%
Basic Rate £12,571 to £50,270 20%
Higher Rate £50,271 to £150,000 40%
Additional Rate over £150,000 45%

To check these rates are up to date, HMRC keep these up to date on their website. 
HMRC also have a useful PAYE tax calculator which can be used to check the income tax you are paying is right.

Who deducts the tax and national insurance contributions and pays them to the UK Government?


When an employee is paid, the employer is obliged to calculate and then deduct income tax paying the employee a ‘net salary’ i.e. after tax. The employer pays the income tax to HMRC.
PAYE is normally split into equal payments spread evenly over the twelve months of the tax year.

Your personal allowance may not be £12,570 as it is affected by your tax code which is explained more fully in our ‘What is your tax code and what does it mean?’

What if I’ve over or underpaid income tax?


If at any time they have paid too much, employees receive a refund that is paid to the employee by the employer. Conversely, if the employee has not paid enough income tax, they will either be charged more through PAYE, or receive a tax bill at year-end showing why they owe more and how to pay. Your payslip will show your contributions.

What is simple assessment for if I pay PAYE throughout the year?


At the end of the tax year, HMRC checks income tax paid by taxpayers who receive PAYE employment and pension income. If you have over or underpaid income tax they will be in touch to request an additional payment or refund you some tax. If the PAYE calculation was correct in the year, then there will be no tax to pay.

If you have other sources of income or earnings greater than £100,000 per annum you may have to file a self-assessment tax return instead.

National Insurance (NI)

The PAYE system also includes a charge for National Insurance (NI) to cover the cost of benefits and the state pension. NI raises a lot of money for the UK Government – in 2021 it raised £158 billion. Like income tax, national insurance is deducted from employees’ salaries by their employer and is paid on earnings over the £12,570 threshold.

What are the national insurance rates?


The amount of NI an employee pays is based on how much they earn, with different rates for different earnings bands:

  • Employees under pension age who earn less than £12,570 a year don’t pay NI.
  • For employees earning between £1,048 and £4,189 per month the rate is 13.25%
  • For employee earnings greater than £4,198, the NI rate is 3.25%.

NI rates were recently increased by 1.25% to fund a new Social Care Levy to pay for the NHS and social care as a result of the COVID19 pandemic and an ageing population.

Employer’s national insurance


Employers also pay national insurance called Employers NI at a rate of 15.05%. However, if eligible employers may be able to reduce their annual National Insurance liability by up to £5,000 per annum by claiming Employment Allowance. If you are unsure if you are eligible or already claiming, check with your accountant.

What are the penalties for getting PAYE wrong?

HMRC have well-documented guidelines on PAYE schedules and procedures to ensure both HMRC and employees are paid on time. If you do not report accurately or fail to report PAYE deductions on time, you may receive a late filing penalty. HMRC are lenient on the first mistake, but after that additional late payments are penalised with a percentage penalty applied to the amount owing that month:

Number of defaults in a tax year Penalty percentage
1 to 3  1%
4 to 6 2%
7 to 9  3%
10 or more  4%

HMRC have produced this helpful video on how and when to pay your PAYE

If an employer does not pay PAYE deductions to HMRC after 3 months, there is an additional late filing penalty of 5% of the unpaid amount. If full payment is outstanding after twelve months then the employer is penalised a further 5% of the unpaid amount.

Payroll at Square Mile Accounting

Square Mile Accountants are payroll experts, with a dedicated payroll team. If you need support with your payroll or to understand your income tax we can help. Please call us today on 0203 282 7109 or email us.

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