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PAYE (Pay As You Earn) - This is the amount of money collected by the employers from their employees through deductions to pay for their income tax. The employer collects the money on behalf of the government and makes payment to the government on particular periods, for example, on monthly basis, on weekly basis or even quarterly a year. The amount of PAYE money that an employee has to be deducted is determined partly full tax year, and also partly by the employee's expected other income. All employees's expected income including expected allowances and reliefs are translated by HM Revenue and Customs (HMRC) into a "tax code". Tables which are published apply the tax code to establish amount of money to be deducted as tax (Chittenden et al 2005).
Workers have to inform the HMRC about the transformation which will influence his or her payments as well as relief and other income in the tax year. Sending the levy by use of HMRC is the duty of the worker or the employee.
Her Majesty's Revenue and Customs (HMRC) this is a non ministerial department of the government that is responsible for tax collections some other forms of state support.
Tax code is the code allocated to each tax payer by the HMRC in order to identify them. It consists of numbers followed by a letter suffix but other non standard codes are also used. Tax codes are changed yearly, but in other circumstances, they can be changed before the end of the year. For example, when a tax payer has changed jobs, or there have been changes in their income, the tax code for this person can be changed (Small Business Research Trust 1998).
An employee who is changing job is given a form which contains information needed by the new employer to operate his PAYE correctly and easily. At the end of every tax year, every employer is supposed to give his/her employee from p 60 which is used to set out employment income and the PAYE tax with held with the course of the ending year.
History of PAYE
PAYE was devised by Paul chambers and introduced to UK in the year 1994. During those times, there were financial strains in the UK brought by the Second World War and this meant that, the government needed more money from the people to help in the smooth running of the government (Carter 2001). The introduction of this tax system was a challenge to both the employer and the employee because they had not used the system before.
Tax or duty structure faced a challenge when it could not calculate taxes of the people who had more than one job. It was also very hard to make corrections and also have timely processing due to the fact that, different offices from different employers were involved and not all of them could make effective communication (Johnsson 2004). In the year 2010, the UK government introduced the use of computers which has led to large volumes of corrections.
How the PAYE system works
Before setting up a PAYE system, you need to register with the HMRC first. After you have registered, you can then set up the PAYE system if you have employees. But if you are limited company, then you become the employee yourself.
The employees earning more than £7,475 have to be deducted the income tax in every end of the year. Employees aged16 years or over are deducted the national insurances contributions. Those employees earning more than £110 a week; have to be deducted under state pension in the tax year 2010/11.PAYE as you earn is applied to all wages, all payments and all sources of income (Godwin et al 1989).
How to set up a payroll system
In order to set up a payroll system that will be used in calculating employee PAYE from their salaries, employers can use:-
An employer can employ an accountant who will be able to do all the calculations within the company. This is the easiest way of calculating the income tax, but there is also possibility of many errors being made by the accountant.
An employer can find a payroll agency that can perform the job, but the employer should always remember that, they are supposed to take responsibilities of any mistakes made. Therefore, if the payroll agent makes any mistakes, the responsibility will not be on the agent but on the employer.
The employer can decide to do it themselves. If one decides to do it himself, they will need to use the following:
They will need payroll software which must first be approved by the HMRC before being used.
You will also need the employer CD-Rom. This one you get together with your employer starter pack and it includes databases and calculators that will help you in creating and maintaining payroll system and also will help you in calculations of income tax and other deductions that need to be done.
A manual wages record is also needed- This will also help you in calculations of all the deductions that need to be done. This is done using a paper and it may sometimes bring concurrencies in the record although sometimes it makes things clearer.
How and when to pay
The employer pays the HRMC the taxes that he has deducted from its employees according to what they have calculated. One may also make payments monthly, only when the payments are not more than £1,500, one may decide to make payments quarterly. If you usually make your payments using electronic methods, you have to pay by 22nd of every month. If you do not use electronic payments, you have to make the payment by 19th of every month. One can pay online so long as you have less than 250 employees. This can be done by debiting directly, use of giro bank, Post Office cashing, as well as using a cheque. Every unpaid or due balances have to be paid to the HRMC by April 19 in any tax year.
Forms needed for PAYE
There are different forms that need to be filled by both the employer and the employee. These include:-
Deductions Working Sheet P11:Its purpose include showing deductions of student loan, NI and tax for example sick, maternity, adoption, etc. This form can also be used to record your wages and is supposed to be started at the beginning of every tax year and should be maintained through out the tax year. In case the employer hires a new employee, a new deductions working sheet should be started because of this new employee.
P32: This is the form that keeps all the detailed records on the total payments done and also all the deductions done for a certain period of time. One may decide to make it weekly, or monthly. One needs this in order to enable you stick to the HMRC rules and also help you in filling the P35 form.
Employee pay slip: This form does not originate from the HRMC but this should be created for each employee in the company every time they are being paid. The employee pay slips contains the following:
Gross wages:-This is the total salary before any deductions have been made on the salary.
Total deductions:- This will show all the deductions that have been made on the gross salary e.g. the income tax, any loan that the employee may have taken and any other deductions that must be deducted from the employee's salary.
Net wages: - This is the remaining salary after all the deductions have been made. It calculated by; gross wages - the total deductions= net wages.
P35: This is form shows the employer's annual return. It shows the total PAYE deductions for all the employees. The form has a room for only ten entries, therefore, if the employer hires a new employee, he needs to get a P35(CS) continuation sheet so as to accommodate this new employee
P14: This form contains the information for each individual employee. It shows all the total payments that the employee has made through out the tax year.
P60: This is a copy of the P14 that the employer gives the employee to keep as evidence that they have paid all their income taxes within the course of the tax year.
P11D: This where all expenses and benefits in kind for the employee are recorded.
All new employees need to send a P45 form to the HRMC. All the forms explained above can be gotten from the HRMC order line, or you can also be downloaded from the HRMC website.
How employers do filling
There are several details that have to be filled by the employers in order to be able to make tax payment easy. Once on the online page, the page provides different spaces where correct information has to be filled. This form works as a calculator that can calculate the total deductions that need to be done on an employee's total income. The following details have to be provided in that page.
Select Year: The tax year is usually displayed by default by the calculator. For example, this tax year is 2010/11. Each tax year in the UK starts on April 6th every year.
Married:- This helps the calculator to know who may have an increased tax free allowances, for example, married couples aged 65 years old may have an increased tax free allowances and do not pay the national insurance.
Blind: - There is an additional allowance that is made available for the blind people. The employer should click this if they do not want to include the national insurance contributions in the calculations.
Student Loan Repayment: - Students who had taken loan during their studies will need to start repaying the loan. However, this is only done after their earnings have gone above a certain threshold. Take for example, this year threshold starts at £15,000, and therefore students earning this much have to start repaying their loans. Click on this option if you want to include the repayment of the student loan.
Age Group: - Individuals over the age of 60 years and are still employed get some additional allowances, and also reduced number of National Insurance contributions.
Additional Allowances / Deductions: - If there are any other additional allowances one wishes to include, they should be indicated here. If you also have any other deductions you would like to add they should be indicated here.
Tax Code: - It is optional to add your tax code but if you know it, you should indicate it.
Gross Income per Year / Month / Week / Day: - One should select the time for which they will be making the payments, different periods are provided for the user to choose.
Wage Summary: - This helps you to select the column from which you want your wage summary to be displayed (Cowe 1997).
Pension: - If you are currently on pension, enter the amount that you pay for your pension in regular basis.
Email Address: once the email address is entered, all detailed are saved and can be used for the next time.
PAYE system of tax collection versus the self-assessment system
While collecting income tax, there is always a challenge when it comes to people with more than one job or people who are not employed but work for themselves. Most of times, it becomes hard to use the PAYE system and therefore, a self-assessment is used in order to make sure that these people also pay for their income taxes (Inland Revenue 1998).
Different laws are imposed on the tax collections. An assessment is the process of ascertaining and knowing the tax payers total income that can be taxed and calculate the tax that can be deduction from the employees total income. There is a notice of assessment, and it becomes final once the statutory period for reviewing it has expired. Self-assessment applies for income tax to:-
People who are self employed and are carrying on with their own business for example farming, trading etc.
People who are receiving incomes from sources that can not be calculated by the PAYE system for example, house rents, foreign exchange income etc.
Under the self-assessment, there is particular date for payment of tax and also for filing of the tax returns. This system allows one to file his/her returns for the year and also the pay the outstanding balances.
Similarities of self-assessment and PAYE
They are both used in payment of the income tax
They both have a specific deadline dates on which all the outstanding balances should be paid
Differences between self-assessment and PAYE
Where else PAYE as you earn system can be used for people who are employed, self-assessment is used by people who are self-employed (Dingeldey 2001).
PAYE is tackled by the employer but the self-assessment is tackled by the person paying the tax
PAYE uses computerized system but the self -assessment does not use computer system.
The date of tax payment for PAYE is different from that of the self-assessment tax payment.
Advantages of PAYE
Both the employer and the employee can get help from the revenue authorities any time they need it.
It is easy to calculate taxes because different methods are available for calculations.
PAYE system is easily manageable unlike the other methods of tax calculations.
The information stored in this system is secure.
It is of high speed, for example, to calculate tax using this system is very easy.
Usability- it is very easy to use this system, as long as one knows how to operate a computer, he/she can be able to use the PAYE system (Logue 2009).
Disadvantages of PAYE system
It is expensive and difficult to find a person to operate the system; the employers have to part with some money to have someone to operate the system.
The employers are the ones who do the deductions; therefore, the burden of making sure that the taxes were deducted is left on them.
Tax may be held incorrectly and payment be made later.
When the income goes up, the system deducts more taxes, it does not look at the fact that, there maybe more deductions that this person may have.
Incase the employee has left an employment; the employer may chose not to pay for the tax that may have accumulated.
PAYE system has made tax payment in the United Kingdom easy. This is because, once the system is installed, the employers are able to easily calculate the amount of money as tax that the employees have made. The system is easy to use and the information stored in the system is secure. Dates have also been set to make sure that, all taxes are paid at the right time and by all employees. Rules have also been set to make sure that no one forfeits the payment of tax at all times. HRMC makes sure that all employers collect the taxes from their employees' on their behalf (HMRC 2005).