PAYE works by making employers deduct Income Tax and National Insurance from every employee’s pay each payday, report the figures to HMRC through payroll software on or before payday, and send the money to HMRC by the 22nd of the following tax month. Pay As You Earn (PAYE) is the UK’s payroll tax collection framework for employment income. Employees settle their Income Tax in instalments across the year instead of receiving one annual bill from HMRC. This guide covers the registration thresholds, the 2026-27 rates, the Real Time Information (RTI) reporting cycle, and the penalties that follow late PAYE.
What Is Pay As You Earn (PAYE)?
Pay As You Earn is HMRC’s system for collecting Income Tax and National Insurance from employment pay. Employers act as collectors: they deduct Income Tax and National Insurance from wages on every payday, then pass the amounts to HMRC. Employees therefore pay tax in instalments across the year rather than facing one annual bill.
PAYE deductions are calculated using 2 identifiers held on every payroll record: the employee’s tax code, which sets the tax-free allowance applied to wages, and the National Insurance category letter, which sets the National Insurance rates that apply.
A PAYE bill can include 6 elements (from GOV.UK, verified 19 Sep 2026):
- Employee Income Tax
- Class 1 and Class 1B National Insurance
- Class 1A National Insurance on termination awards and sporting testimonials
- Student loan repayments
- Construction Industry Scheme (CIS) deductions
- Apprenticeship Levy, charged where the employer’s annual pay bill exceeds £3 million
When Do Employers Need to Register for PAYE?
Employer PAYE registration becomes a legal duty as soon as any employee is paid £96 or more a week, receives expenses and company benefits, receives a pension, holds another job, or has received Jobseeker’s Allowance, Employment and Support Allowance or Incapacity Benefit (from GOV.UK, verified 19 Sep 2026). A company must register even where its only paid person is a director.
Registration timing carries 2 rules: register before the first payday, and register no more than 2 months before it. HMRC posts the employer PAYE reference number to the registered business address, and the post takes up to 15 working days. Employers who register late risk missing their first FPS deadline.
Directors meet this duty early in a company’s life. First employees usually arrive immediately after limited company formations complete, and a company paying only its own director still needs a PAYE scheme. Where pay stays below £96 a week and none of the other conditions apply, no scheme is required, but payroll records must still be kept (from GOV.UK, verified 19 Sep 2026).
How Does the PAYE System Work in Practice?
The PAYE system works on tax months: each tax month runs from the 6th of one month to the 5th of the next, and every report, claim and payment inside that cycle shares the same set of deadlines.
On or before each payday, payroll software must complete 5 tasks (from GOV.UK, verified 19 Sep 2026):
- Record each employee’s pay
- Calculate Income Tax using the employee’s tax code
- Calculate employee National Insurance using the category letter
- Calculate employer National Insurance and produce payslips
- Report every payment and deduction to HMRC in a Full Payment Submission (FPS)
New starters set the tax code from their P45. HMRC’s starter checklist replaces the P45 where an employee cannot provide one.
What are the 2026-27 Income Tax and National Insurance rates?
The 2026-27 rates charge 20% Income Tax on taxable income up to £37,700, 8% employee National Insurance between £12,570 and £50,270, and 15% employer National Insurance on pay above £96 a week. The table below sets out every threshold payroll software applies during the 2026-27 tax year (from GOV.UK, verified 19 Sep 2026).
| Deduction | Band | Rate |
|---|---|---|
| Personal Allowance | £12,570 a year (£1,048 a month, £242 a week) | Tax-free |
| Income Tax basic rate | Taxable income up to £37,700 | 20% |
| Income Tax higher rate | £37,701 to £125,140 | 40% |
| Income Tax additional rate | Above £125,140 | 45% |
| Employee NI, category A | Up to the £12,570 primary threshold | 0% |
| Employee NI, category A | £12,570 to the £50,270 upper earnings limit | 8% |
| Employee NI, category A | Above £50,270 | 2% |
| Employer NI | Above the £96 a week secondary threshold (£417 a month, £5,000 a year) | 15% |
The Employment Allowance reduces the employer National Insurance bill by up to £10,500 a year, and employers claim it through an EPS.
What other deductions does payroll software handle?
Payroll software also handles 5 further deduction types: student loan repayments, pension contributions under automatic enrolment, Payroll Giving, child maintenance, and attachment of earnings orders. Student loan deductions apply above plan thresholds at 2 rates (from GOV.UK, verified 19 Sep 2026):
- Plan 1: 9% above £26,900
- Plan 2: 9% above £29,385
- Plan 4: 9% above £33,795
- Plan 5: 9% above £25,000
- Postgraduate: 6% above £21,000
What deadlines fall in each tax month?
Three deadlines fall in the tax month after every payday. Employers view the amount owed online from the 10th, send an Employer Payment Summary (EPS) by the 19th to claim reductions such as statutory pay recovery or the Employment Allowance, and pay HMRC by the 22nd, or by the 19th when paying by cheque. Employers usually paying HMRC less than £1,500 a month can ask to pay quarterly instead.
Our payroll services in Newcastle run these RTI deadlines every month for North East employers, including EPS claims and quarterly payment arrangements.
What Happens If PAYE Is Paid or Reported Late?
Late PAYE reports and payments attract separate penalties: HMRC charges filing penalties for late FPS submissions and payment penalties that rise with each default in the tax year.
Late FPS reports draw a late-filing notice first. HMRC charges no penalty for delays up to 3 days, then scales the penalty with employee count: £100 per month for 1 to 9 employees, issued quarterly (from GOV.UK, verified 19 Sep 2026).
Late payment penalties follow a set ladder. The first late payment in a tax year carries no penalty. The table below shows the percentage added to each late amount after that (from GOV.UK, verified 19 Sep 2026).
| Late payments in the tax year | Penalty on the amount late |
|---|---|
| 1 to 3 defaults | 1% |
| 4 to 6 defaults | 2% |
| 7 to 9 defaults | 3% |
| 10 or more defaults | 4% |
Daily interest also runs on late payments. HMRC adds a further 5% penalty where a payment stays unpaid after 6 months, and another 5% after 12 months (from GOV.UK, verified 19 Sep 2026).
Two further risks sit outside the penalty ladder. HMRC closes a new employer’s PAYE scheme where no report or payment is made within 120 days. Late or incorrect payroll reports also affect employees’ income-related benefits such as Universal Credit, because benefit awards rely on pay reported through RTI.
Year-end duties close the PAYE cycle. The final FPS goes to HMRC on or before the last payday of the tax year, 5 April. Payroll software and records update from 6 April. Employees receive their P60 by 31 May, and expenses and benefits forms (P11D) reach HMRC by 6 July (from GOV.UK, verified 19 Sep 2026).
Common Questions Answered
How does PAYE work for a limited company director?
PAYE works for a director in the same way as for any employee: the company registers a scheme, runs the director’s salary through payroll, and calculates Income Tax and National Insurance using the director’s tax code. A company must register for PAYE even where the director is the only person paid (from GOV.UK, verified 19 Sep 2026). Directors’ National Insurance is calculated using the annual (cumulative) method or the pro-rata method, and payroll software applies the chosen method automatically.
How much can an employee earn before PAYE applies?
PAYE registration applies once any employee earns £96 or more a week, or receives expenses and company benefits, receives a pension, holds another job, or has received JSA, ESA or Incapacity Benefit (from GOV.UK, verified 19 Sep 2026). Below these conditions no scheme is needed, but payroll records must still be kept.
What is the difference between an FPS and an EPS?
An FPS and an EPS differ on timing and purpose: an FPS reports each employee’s pay and deductions on or before every payday, while an EPS goes to HMRC by the 19th of the tax month to claim reductions such as statutory pay recovery or the Employment Allowance. An EPS is also required in any tax month where no employees were paid at all.
When do I pay HMRC the PAYE I deduct?
Monthly payers send PAYE to HMRC by the 22nd of the next tax month, and tax months run from the 6th to the 5th. Quarterly payers pay by the 22nd after the quarter end, so the 6 April to 5 July quarter clears by 22 July. Cheque payments must reach HMRC by the 19th instead (from GOV.UK, verified 19 Sep 2026).
How Aqua Accounting Can Help
Aqua Accounting helps North East employers run PAYE end to end: scheme registration, monthly FPS and EPS submissions under Real Time Information, year-end P60 and P11D duties, and the payroll records HMRC expects employers to keep. We are an ICAEW Registered Member Firm of Chartered Accountants, and our UK-based team has 13+ years of experience serving North East businesses from Newcastle upon Tyne.
Where payroll connects to the wider ledger, our bookkeeping services keep every wage posting reconciled against the bank. Aqua Accounting supports limited companies, sole traders and contractors with tax, payroll and accounts work in one place.
Understanding how Pay As You Earn works protects both employer and employee: Income Tax and National Insurance leave pay in instalments each payday, reach HMRC by the 22nd, and leave a clean record with every FPS. Contact our team to set up or review your PAYE scheme before the next tax month begins.
Disclaimer:
The information provided in this blog is for general informational purposes only and does not constitute professional advice. While every effort is made to ensure accuracy, Aqua Accounting accepts no responsibility for any actions taken based on this content. You should seek professional advice tailored to your individual circumstances.
Omar Ahmed is an ICAEW Chartered Accountant and the Director of Aqua Accounting, a UK-based accountancy practice providing expert accounting and tax services to individuals, sole traders, and small to medium-sized businesses. As a trusted accountant in Newcastle, he offers expertise in annual accounts, self-assessment tax returns, company accounts, VAT, payroll, bookkeeping, and company formation.
With a strong focus on delivering clear and practical financial advice, Omar helps clients stay compliant while improving their understanding of their finances. Through Aqua Accounting, he works closely with business owners to simplify accounting processes, meet tax obligations, and support informed financial decision-making.