How to Set Up a PAYE Scheme for Your UK Business
If your UK business is hiring employees or paying yourself as a director, you’re legally required to set up a PAYE (Pay As You Earn) scheme. PAYE allows HMRC to collect Income Tax and National Insurance contributions (NICs) directly from employee wages.
In this guide, we’ll take you through the step-by-step process of setting up a PAYE scheme for your business, ensuring you meet your legal obligations while managing payroll efficiently.
What Is PAYE and Why Is It Important?
PAYE (Pay As You Earn) is HMRC’s system for collecting Income Tax and National Insurance Contributions (NICs) directly from an employee’s salary before they receive their wages. It ensures that taxes are deducted at the source, helping both employees and the government maintain a smooth and efficient tax process.
If you employ staff or pay yourself as a director of a limited company, setting up a PAYE scheme is a legal requirement in most cases. You must operate PAYE if any of the following conditions apply:
- An employee earns more than £123 per week (£533 per month or £6,396 per year).
- You are paying salaries to directors of a limited company.
- Employees receive expenses and benefits (e.g., company cars, health insurance, bonuses).
Without a PAYE scheme, businesses cannot legally process payroll for their employees, leading to potential penalties from HMRC. Setting up a PAYE scheme correctly ensures that tax and NICs are deducted accurately, avoiding compliance issues.
For full guidance, visit HMRC’s PAYE for employers page.
Step 1: Register as an Employer with HMRC
Before you can set up a PAYE scheme, you must register as an employer with HMRC. This applies even if you are the only employee (e.g., a sole director of a limited company paying yourself a salary).
When to Register
You should register at least four weeks before your first payday to allow HMRC time to process your application. However, you cannot register more than two months before you start paying employees.
How to Register
- Visit the official HMRC Employer Registration page.
- Provide details about your business, including:
- The legal structure (sole trader, partnership, or limited company).
- Your business name and address.
- The date you will start paying employees.
- Your company’s Unique Taxpayer Reference (UTR) (if applicable).
What You’ll Receive After Registering
Once your registration is complete, HMRC will issue:
- Employer PAYE Reference Number – This is used to identify your business when submitting payroll information.
- Accounts Office Reference Number – This is required for making PAYE payments to HMRC.
These reference numbers are essential for managing payroll, filing Real-Time Information (RTI) returns, and ensuring compliance with PAYE regulations.
Step 2: Choose Payroll Software
To efficiently set up a PAYE scheme, you’ll need payroll software to calculate employee wages, tax deductions, and submit Real-Time Information (RTI) reports to HMRC. Choosing the right software ensures accuracy, compliance, and efficiency in managing payroll.
Key Features to Look For
When selecting payroll software, consider:
- HMRC-Recognised Software – Ensure your chosen software is compatible with HMRC’s RTI system. Check the full list of approved software here.
- Automatic Tax Calculations – The software should handle Income Tax, National Insurance Contributions (NICs), and student loan repayments.
- Payslip Generation – Easily create and distribute digital or printed payslips for employees.
- RTI Submission to HMRC – The software must allow you to submit payroll reports (FPS & EPS) directly to HMRC, as required by PAYE regulations.
- Pension Auto-Enrolment Support – If you employ staff, your software should help with automatic pension enrolment to stay compliant with workplace pension laws.
Popular Payroll Software Options
Free Payroll Software (For Small Employers)
- HMRC Basic PAYE Tools – A simple, free tool for businesses with fewer than 10 employees. However, it lacks features like payslip generation and automation.
Paid Payroll Software (For Growing Businesses)
- Xero Payroll – Ideal for small and medium-sized businesses, with automation and integration with accounting software.
- QuickBooks Payroll – A user-friendly option that syncs payroll with your financial records.
- Sage Payroll – Comprehensive payroll management with pension auto-enrolment features.
- BrightPay – A cost-effective solution for businesses needing easy payroll processing and RTI compliance.
Choosing the right payroll software is crucial for streamlining your PAYE scheme, ensuring compliance with HMRC, and reducing administrative burden.
Step 3: Collect Employee Details
To correctly set up a PAYE scheme, you must collect key details from each employee before running payroll. This ensures that Income Tax and National Insurance Contributions (NICs) are calculated accurately.
Essential Employee Information to Collect
- Full Name and Address – Ensures proper identification and accurate record-keeping.
- National Insurance (NI) Number – Required for reporting tax and NI contributions to HMRC.
- Employment Start Date – Helps determine tax codes and payroll processing.
- Bank Details – If paying wages via bank transfer, collect the employee’s account number and sort code.
- Right to Work Documentation – If hiring a new employee, you must check their right to work in the UK. You can do this via the GOV.UK Right to Work checker.
Tax Information: P45 or Starter Checklist
You need to determine the correct tax code for each employee. To do this, request one of the following:
- P45 Form – If the employee has worked elsewhere in the same tax year, they should provide a P45 from their previous employer. This form shows their earnings and tax details so far.
- Starter Checklist – If they don’t have a P45, they must complete HMRC’s Starter Checklist. This form helps you apply the correct tax code and avoid emergency tax deductions.
Collecting and verifying these details is an essential step in registering employees for PAYE and ensuring smooth payroll processing.
