What Is PAYE? A Guide for Small Business Employers

The moment you take on your first employee, you become responsible for something called PAYE - Pay As You Earn. It is the UK tax system that requires you, as an employer, to deduct income tax and National Insurance from your employee's wages and pay those amounts to HMRC on their behalf. You are not just paying someone a salary. You are also acting as a tax collector for the government, and HMRC holds you to account for getting it right.

This guide walks through everything you need to know as a first-time employer in the UK - from registering with HMRC through to avoiding the penalties that catch small businesses out.

What PAYE Actually Is - and Why You Are Now Responsible for It

PAYE is not software. It is not a service you buy. It is a legal framework established by HMRC that governs how employees pay income tax and National Insurance throughout the year - rather than in a lump sum at the end of it.

Before PAYE, workers settled their own tax bills annually. The employer's role in PAYE changed that: you now calculate, deduct, and remit those amounts every time you run payroll. Your employee receives their net pay - what is left after deductions - and HMRC receives the rest from you.

National Insurance (NI) - a separate contribution that funds state benefits and the NHS - works similarly. As an employer, you deduct the employee's NI contribution from their wages, and you also pay an additional employer NI contribution on top of their gross pay. Both amounts go to HMRC.

As soon as you pay an employee - including a part-time worker, a family member on your books, or yourself as a director taking a salary - the PAYE obligation applies. There is no threshold of employees at which it kicks in. One employee is enough.

When Do You Need to Register as an Employer With HMRC?

You must register as an employer with HMRC before your first payday - not after. HMRC recommends registering at least two weeks before you pay anyone for the first time, because it can take up to five business days to receive your employer PAYE reference number and accounts office reference, both of which you need to submit payroll information.

You register online through the HMRC website. Once complete, HMRC will send you two reference numbers:

• Your employer PAYE reference - used when filing payroll information to HMRC.

• Your accounts office reference - used when making PAYE payments to HMRC.

Keep both references safe. You will use them repeatedly, and losing track of them causes unnecessary delays when deadlines are approaching.

What a PAYE Tax Code Is and Why It Matters for Your Employee

A tax code is a number and letter combination - such as 1257L - that tells you how much income tax to deduct from your employee's wages. HMRC assigns a tax code to each employee based on their personal tax-free allowance, previous employment history, and any benefits in kind they receive.

The most common code is 1257L, which represents the standard personal allowance - the amount someone can earn each tax year before paying income tax. Different codes apply when employees have multiple jobs, outstanding tax owed from previous years, or are on emergency tax.

You get the tax code in one of three ways:

1. Your employee provides a P45 from their previous employer, which includes their current tax code.

2. HMRC sends you a tax code notice (called a P6 or P9) directly.

3. You use an emergency tax code while waiting for the correct code to arrive.

Using the wrong tax code means deducting too much or too little tax. The employee may end up with a tax underpayment to settle with HMRC, or a refund owed to them. Neither reflects well on you as an employer, even if the error originated with incomplete information. Always use the code HMRC has issued, and update it promptly when HMRC instructs you to.

How to Run Payroll: What You Must Do Each Pay Period

Running payroll means calculating, recording, and processing pay for each employee every time a pay period ends - whether that is weekly, fortnightly, or monthly. The sequence is the same regardless of how you run it.

Employer NI is currently charged at 15% on earnings above the secondary threshold of £5,000 per year (£417 per month) - rates that apply for both 2025/26 and 2026/27. Thresholds can change each April, so always confirm current figures on HMRC's employer rates and thresholds page and check that your payroll software has been updated.

Real Time Information: What RTI Means and How to Submit It

Real Time Information - usually called RTI - is the system HMRC uses to receive payroll data from employers. Before RTI was introduced, employers submitted payroll details annually. Now, you must report every time you run payroll, on or before the day you pay your employee.

Each RTI submission is called a Full Payment Submission (FPS). The FPS tells HMRC the gross pay, tax deducted, NI deducted, and payment date for each employee. HMRC uses this data to confirm the PAYE amounts you owe for that period.

If you have no employees to pay in a given period - for example, if a member of staff is on unpaid leave - you may also need to submit an Employer Payment Summary (EPS). An EPS tells HMRC that no FPS is due for that period, or it adjusts the amount HMRC expects you to pay (for example, if you are reclaiming statutory pay).

RTI submissions are made electronically. You cannot submit them by post or phone. In practice, most small employers use payroll software to generate and send FPS submissions automatically. HMRC also provides a basic PAYE tool (a free product for small employers) that handles RTI filing if you prefer not to buy commercial software.

When and How to Pay HMRC: PAYE Payment Deadlines

Submitting RTI and actually paying HMRC are two separate steps. Submitting your FPS on time does not mean the money has been paid - you still need to make the PAYE payment separately.

Most small employers pay HMRC monthly. The deadline for monthly PAYE payments is the 19th of the following month if paying by cheque, or the 22nd of the following month if paying electronically. So if you run payroll in April, your PAYE payment is due to HMRC by 22 May (electronic) or 19 May (cheque).

The amount you pay is your total PAYE liability for the period - income tax deducted from employees, employee NI contributions, and your employer NI contributions, minus any statutory payments you are permitted to reclaim (such as Statutory Maternity Pay, where eligible small employers can reclaim a portion from HMRC).

You pay using your accounts office reference. Payments can be made by bank transfer, Direct Debit, or through your HMRC online account. Using the correct reference is essential - HMRC cannot automatically match an unidentified payment to your account, which can result in a recorded underpayment even when you have paid in full.

What Happens If You Get PAYE Wrong: Penalties and How to Avoid Them

HMRC's penalty regime for PAYE is automated. This means late submissions and late payments generate notices without anyone at HMRC making a judgment call. The system flags the breach and issues the penalty. Understanding where the risks lie is the practical way to avoid them.

Late RTI submissions

If you submit your FPS after payday - even by one day - HMRC can charge a penalty. The penalty amount depends on how many employees you have and how many months in the year late submissions occur. New employers have a 30-day penalty-free window from the date of their first required RTI submission. After that initial period, the standard late filing penalty regime applies in full.

Late PAYE payments

Late payment of PAYE to HMRC attracts a penalty based on how many times in the tax year you have paid late. The first late payment in a tax year does not result in a financial penalty, but repeat late payments attract escalating charges - starting at 1% of the unpaid amount from the second default. HMRC also charges interest on overdue amounts. Consistent late payment can trigger more formal compliance action.

Incorrect deductions

If you apply the wrong tax code or calculate NI incorrectly, HMRC may identify a discrepancy between what you reported and what you paid. This can lead to an underpayment demand, or in serious cases, a formal compliance check. Keeping your payroll records accurate and your tax codes up to date is the most reliable protection against this.

Do You Need Payroll Software or Can You Do This Manually?

Technically, you can manage PAYE without commercial payroll software. HMRC provides a free Basic PAYE Tools product that handles tax and NI calculations and submits RTI for employers with fewer than 10 employees. Note that it does not generate payslips. It is functional, free, and HMRC-compliant - which makes it a reasonable starting point for small employers who want to keep costs low.

The case for dedicated payroll software grows quickly once you factor in time, error risk, and integration with your accounts. Most small business accounting platforms include payroll, though the structure varies. FreeAgent includes payroll as standard in all plans. Xero and QuickBooks both offer payroll as a paid add-on.

Pricing changes frequently - always verify on the vendor's website before purchasing. These tools automate tax code updates, calculate current-year NI rates, submit RTI automatically on payday, and keep your payroll records in a format that is easy to review.

The question is not really software versus manual. It is where your time is worth more. For most early-stage owners with one or two employees, a low-cost payroll tool is worth the monthly fee simply to eliminate the risk of a missed RTI submission.

Whatever route you choose, the underlying PAYE obligations are the same. Software does not change what you owe or when - it just makes it harder to get wrong.

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