If you’ve set up a Limited Company, then you’ll need to register as an employer with HMRC whether you plan to employ someone or even if you are a Director Only Company planning to pay yourself a salary from your LTD so that you can take full advantage of the tax benefits of incorporation.
In this guide, I’ll explain more about how payroll works for UK small businesses including what you need to report to HMRC and your employees, as well as the deductions and processes you’ll be made legally responsible for as an employer.
Not sure how to pay yourself tax efficiently from your LTD? Then read this guide on paying yourself from your Limited Company.
Updated 26 October 2021
Table of contents
1. How Does Payroll Work?
If you are a complete beginner to payroll, then let’s start with the basics of what you need to do and why for your small business. Payroll, in simple terms, is a list of employees that work for a business, for whom the business is responsible for paying via the PAYE system. If you employ freelancers who are self-employed, then you’ll be paying them via an invoice and this guide does not apply to them (unless you feel you are in breach of IR35) because they are outside of the PAYE regulations and are responsible for their own taxes.
Take a look at the payslip below or even your own one if you are employed and self-employed. The first line is gross pay and often that is the salary you’ve agreed to pay someone to work for you as per their contract. Next, there are then deductions for income tax, national insurance and pension contributions.
As an employer, it is your responsibility to work out how much you need to deduct for each of these items and pay your staff the amount left (called net pay). You’ll also notice that there is a tax code, 1250L, on the payslip, this will be sent to you by HMRC for each person you employ but this is one of the pieces of information you’ll need to run payroll correctly, even if it is just for yourself.
In summary, as an employer, you are legally responsible for:
- Paying your staff in accordance with their signed employment contract;
- Managing PAYE on behalf of your employees, deducting for income tax, national insurance and pension contributions on behalf of HMRC in line with each individuals tax code and paying your staff what’s remaining after these deductions (net pay);
- Paying deductions you’ve made from each employees pay over to the appropriate authorities eg: HMRC and Pension Providers by set deadlines each month;
- Manage and make adjustments for allowances like maternity pay and statutory sickpay or construction industry scheme payments and student loans;
- Understand payments that are subject to additional tax because they are a benefit in kind;
- Keep payroll records;
- Report payroll information to HMRC monthly or annually, as required;
- Providing a payslip every time you pay someone on your payroll.
2. What is PAYE?
As an employer, you’ll know how much tax to deduct because HMRC will either send you a tax code telling them you much to deduct, or you’ll find it on your employees P45 or starter form if they don’t have a P45 (previously called a P46). Tax codes can take account of other deductions needed such as taxable state benefits so it is important to use the code sent to you from HMRC, and not one requested by your employee because they may need to pay deductions that you are not aware of.
To get information such as tax codes, report on tax deductions and make payments to HMRC, you’ll need to register with HMRC as an employer so you have an ‘.GOV account’ within which to manage your payroll reporting and payments. HMRC can then send you coding notifications, known as a P6, either online or by post.
If you haven’t registered yet, then you can find more about this in my guide to Registering as an Employer with HMRC. Ideally, try to register a month before your first payday, because that should give you sufficient time to be accepted by HMRC and your employer’s reference number to be issued.
You do not need to register for PAYE if none of your employees are paid £120 or more a week or receive expenses and taxable benefits in kind, have another job or get a pension. But you must still keep payroll records.
3. PAYE Payment Deadlines
Deductions you make on behalf of your employees obviously do not belong to you and need to be paid over to HMRC periodically. The deadline for making paying PAYE to HMRC is:
- the 22nd of the next tax month following the end of the calendar month, if you pay your staff monthly
- the 22nd of the next tax month at the end of the quarter if you pay your staff quarterly – for example, 22 July for the 6 April to 5 July quarter
The easiest way to pay is by a bank transfer but whichever way you choose make sure you leave enough time for the payment to clear by the deadline otherwise you may face late payment interest or penalties. You must also use the correct PAYE payment reference which is a 14 digit code made up of your employer reference, the tax year and the month you are paying. It is essential to include this with every payment you make so that HMRC allocates your payment correctly and doesn’t think you are paying late.
You should contact your chosen pension provider to confirm the payment date for pension deductions but generally, these must be paid over by the 10th of each month.
4. Payslip Deductions
As an employer, it is your responsibility to manage statutory payments that need to be deducted from individuals salaries on behalf of the government. That includes things like:
5. Benefits in Kind
As an employer you can choose to give your staff added extras to make a job role more attractive or to incentivise them. Things like:
- Company car
- Parking spaces at work
- Gym memberships
Some of these perks attract additional tax and national insurance for both the employee and employer, even though no cash amount has been paid to employees. These types of perks are known as HMRC benefits in kind and tax is based on the cash value of the BIK provided in most cases. As an employer it’s up to you to understand which perks you offer are subject to additional tax, fill out P11d forms, if applicable, and pay extra tax and national insurance.
6. Keeping Payroll Records
Just like accounting records, HMRC requires registered employers to keep payroll records that accurately show:
- how much you’ve paid your employees and deductions made
- reports and payments made to HMRC
- records of employee holidays and sick leave
- P6 coding notices
- P45s for leavers
- P60 summaries
- P11d forms detailing taxable benefits in kind
You’ll need to keep payroll records for 3 years from the end of the tax year they relate to. If you do not keep full records, HMRC may charge you a penalty of up to £3,000.
7. Payroll Reporting to HMRC
Every time you pay the individuals on your payroll, you’ll need to report to HMRC details including:
- Who was paid, along with their personal details such as national insurance number;
- Gross pay and deductions;
- Tax code;
- Statutory payments made such as maternity pay.
Employers do this online in their .GOV payroll account using what is called ‘RTI submissions‘. An RTI submission contains all the essential pieces of information about the payroll you have run, so it can be passed to HMRC so that each individuals tax records can be updated and they know how much tax & national insurance to expect to be paid over to them by the 22nd of each month.
8. Producing Payslips
A payslip is a legal document, either issued digitally or on paper, detailing how much an employee has been paid as well as any deductions made from their pay. The purpose of a payslip is to give the individual being paid absolute clarity on how much they’ve been paid and why deductions have been made before their salary hits their bank account.
As an employer, it is your legal responsibility to provide your employees with a payslip every time you pay them so they can see what deductions you’ve made from their salary and why. How you choose to produce your payslip depends on how you decide to run your payroll.
9. Choosing a Payroll System
Luckily there is a range of options to choose from when it comes to running payroll that automates calculations, manages your employees, starters, leavers and tax codes. They also integrate with HMRC to send your RTI submissions directly to them once you’ve finalised your payroll for the period.
When it comes to choosing a payroll system you have the option of DIY-ing it or outsourcing it to a payroll company/accountant.
If you choose to DIY it then accountants and small business owners tend to rave about using the HMRC’s Basic PAYE Tools which is a free payroll software from HMRC suitable for employers with up to 10 members of staff.
Alternatively, Xero accounting offers a payroll add on starting at £5 per month and is a fully comprehensive payroll suite that integrates with HMRC. And if you are a Xero user, your accounts will be automatically updated with the payroll journal when you finalise your pay run.
- How to Register as an Employer with HMRC
- How Does Tax Relief Work on Workplace Pensions?
- HMRC Starter Checklist for Payroll
- What is an RTI Submission to HMRC?
- Employment Allowance Explained
- Payslips Explained
- Tax Code 1257l Explained
Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.