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PAYE Explained


Paying tax is one of the constants in life for those who are employed, and for the majority of employees the tax is collected through the government’s PAYE (Pay As You Earn) system. The tax is deducted directly from the weekly wage or the salary at the end of the month.

Although most people complain about tax, it is worth remembering that the money contributes to central government’s spending on the many services provided that benefit everyone in the country, from health and transport, to education and defence. The PAYE system means that tax is taken in advance of what is expected to be due at the year-end; if an employee is found to have paid more than they should have at the year-end, they are entitled to a refund.

Tax codes

An employer collects the tax on behalf of Her Majesty’s Revenue and Customs (HMRC) using a tax code allocated by HMRC, and remits that money directly to the government. The tax code determines how much each employee is permitted to earn before starting to pay tax.

Tax codes vary according to an individual’s circumstances, with the most common one denoting the basic personal allowance, starting with three digits and followed by L. Multiplying these three digits by ten, and adding five, shows the amount an employee can earn before tax is applied to earnings. Thus the code 810L, which is the basic personal allowance in the 2012/13-tax year, means the employee can earn up to £8,105 before being liable for tax.

Tax is then applied according to percentage rates set annually by the government (the reason that the Budget is listened to so carefully by employers and employees). A basic rate of taxation is applied to earnings over the PAYE tax threshold, and a higher rate applied when earnings reach a particular level, again set annually.

Tax rates do move up and down, often rising if the economy is struggling, or being lowered when the country is experiencing a period of growth. However, it is the government’s fiscal strategy that will determine where rates are set, and there are usually political as well as financial circumstances to be considered.

Reducing the burden for employers

Tax issues are, as might be expected, taxing for employers to deal with. There are many complexities within the taxation system, and though PAYE may appear straightforward it can take considerable time to deal with the intricacies, especially for small or start-up businesses. Getting it wrong is not an option, as HMRC is not slow to hand out fines for errors or late payments.

A growing way for businesses to deal with PAYE, and many other administrative tasks, is by using an umbrella company to reduce the burden on the business owner. These companies will effectively act as an employer and are especially helpful for entrepreneurs starting their own businesses, as well as freelancers. An umbrella company will contract with clients, rather than the business having to do it directly, and will receive payment from each client, passing it on to the business after taking an agreed cut for the administrative services provided.



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