PAYE and National Insurance Contributions - what you need to know

Taking on first employees is an important step in the life of a growing business. But it is not without cost. Before hiring staff, you must have a number of financial processes in place to enable you to meet your tax obligations.

In many cases, businesses cannot hope to take advantage of new market opportunities unless they have a committed workforce of a suitable size. Most prospective employers will already have allowed for the salary that they will have to pay their new staff members, as well as the basic expenses associated with the recruitment process – including agency fees and advertising costs.

But it is all too common for small businesses hiring their first employees to forget that there is also a significant tax burden. The most significant and potentially time consuming part of this is a PAYE system.

Setting up PAYE

As an employer you are obliged to make tax deductions from your employees’ pay. The deductions are made as your employee earn their wages; normally on a monthly basis. You must then pay HM Revenue and Customs (HMRC) the amount you have deducted on either a monthly or quarterly basis. This applies to all employees with earnings at or above the Lower Earnings Limit. This is set at £95 per week, £412 per month or £4,940 per year for the 2009-10 tax year.

HMRC provide a range of tools to help new employers set up a system for making and paying these deductions quickly and efficiently. When you first register as an employer you will be sent a New Employer pack. This includes computer software to help you calculate the deductions, and a series of forms to enable you to fulfil your record keeping obligations.

Some accounting software also includes PAYE support. If you use a modular accounting package like SAGE, you may be able to purchase a PAYE add-on to streamline the process. Although this can be more expensive, it has the significant benefit of requiring little or no additional training.

Filing and paying PAYE

HM Revenue and Customs are gradually phasing out paper filing, and almost all employers are now required to file PAYE forms online. You must therefore register for the PAYE Online scheme, which requires a Government Gateway username. This can be obtained from the HMRC website.

You will have to file an Employer Annual Return online. This replaces the previous paper forms P35 and P14. If you have 50 or more employees you must also file a number of ‘in-year’ forms online (that is, forms that are not filed on annual dates but are required only in certain circumstances). These include P45 and P46.

As of April 2011 this requirement will be extended to firms with fewer than 50 employees, so you may wish to familiarise yourself with the process now. You will also need to use form P11, which allows you to keep track of deductions made throughout the year. You will require one P11 for each employee.

National Insurance Contributions

As an employer you are also required to make National Insurance Contributions (NICs) on your employees’ behalf. This is also carried out through the PAYE system.

The most common National Insurance deductions that must be made by employers are those for Class 1 NICs. These must be deducted from the wages of any employee whose earnings exceed the lower earnings limit (LEL). The LEL is set at £95 for the 2009-10 tax year, and will rise to £97 for 2010-11.

If your employees receive any taxable benefits you will also be required to make deductions for Class 1A National Insurance Contributions. These deductions are made on most benefits in kind, and are payable on behalf of any employee earning £8,500 or more in a year.

Firms that make use of a PAYE Settlement Agreement with HMRC will also have to pay Class 1B NICs. The PAYE Settlement Agreement is a way of simplifying tax payments for expenses and benefits in kind. It is not suitable for all firms, and you will not automatically be enrolled in it.

Registering as an employer

If you are taking on staff for the first time, you will almost certainly have to register as an employer. Broadly speaking, registration is necessary if you are paying the employee at or above the PAYE threshold or the Lower Earnings Limit, or if the employee already has another job. You can register up to four weeks before the date on which the employee will first be paid.

It is generally simplest to register with HMRC by phone. You can do this by calling the New Employer Helpline on 0845 60 70 143.

Finally, it is vitally important that you keep on top of your PAYE and National Insurance obligations as an employer. There are severe penalties for businesses that fail to make proper deductions and payments, or that do not keep accurate records.