Taking place this week, National Payroll Week was established to raise the profile and awareness of payroll in this country.
A payroll system is a necessity for all employers, to ensure that employees get paid according to their contract of employment and that income tax and National Insurance contributions (NICs) deductions are made and recorded in compliance with employers' statutory obligations.
In this article we take a look at what must be considered when setting up a payroll system, the information that must be obtained from each employee and what must be done regularly to ensure that the payroll system works effectively.
Employers' payroll duties
Employers have a contractual obligation to pay staff according to their terms of employment and the National Minimum Wage. They also have a statutory obligation to register with HM Revenue & Customs (HMRC) as an employer and to calculate employee and employer income tax and NICs deductions through the Pay As You Earn (PAYE) system.
Employers must pay these deductions to HMRC and maintain accurate payroll records (see BIF458 Pay As You Earn (PAYE)). They are required to submit payroll information to HMRC online on or before the date on which they pay their employees.
A payroll system is used to pay employees - weekly, fortnightly, every four weeks or monthly - and there may be serious consequences for the employer if it is run incorrectly. PAYE and NICs rates and thresholds change regularly and these need to be monitored and implemented accurately.
Reporting PAYE information to HMRC
Employers must report PAYE information to HMRC using the PAYE Online service, which enables payments to employees to be reported online as they are made, rather than at the end of the tax year.
On or before the day that employees are paid, their employer must submit a Full Payment Submission (FPS) to HMRC, including the following information:
How much was paid to the employee(s).
Details of deductions, for example for income tax and NICs.
Information about new employees and leavers.
Go to www.gov.uk/running-payroll/reporting-to-hmrc for further information about submitting payroll information to HMRC.
How does a payroll system operate?
The main processes that a payroll system needs to perform are:
- Collecting and recording employee details.
- Calculating gross and net pay.
- Providing employees with pay statements.
- Reporting PAYE information to HMRC in real time.
- Paying deductions to HMRC and pension providers.
- Producing standard forms when required.
- Maintaining and keeping accurate records.
Some of the processes of a payroll system can be operated using free payroll software supplied by HMRC, known as Basic PAYE Tools. For more information, go to www.gov.uk/government/collections/guidance-for-employers-on-using-basic-paye-tools-bpt.
However, Basic PAYE Tools has some limitations. For example, it cannot be used to produce payslips. HMRC provides guidance about other available payroll software at www.gov.uk/payroll-software.
What information must be collected and recorded for each employee?
Employers must collect basic information from new employees to ensure that the payroll system is run accurately. Key details include:
- Full name.
- Home address.
- Employment start date.
- Date of birth.
- National Insurance number.
- Leaving date from their last job.
- Total pay and tax paid to date for the current tax year.
- Student loan deduction status.
- Bank details, if payment is to be made directly into their account.
Details of each new employee must be submitted to HMRC as part of the regular FPS. A new employee who has previously worked for another employer should be able to provide their new employer with a P45 form issued by their previous employer, which will provide some of this information. The leaving date on the P45 form must be within the current tax year. If it is not, or if the new employee cannot provide a P45, their new employer should use the HMRC 'starter checklist' (previously the P46 form) to gather the required information.
Some employee details, such as home address and rates of pay, may change during a person's employment, so employers need to ensure that their records are updated as necessary.
Employers must also record details of any expenses and benefits provided to each employee, as this information must be provided to HMRC annually and can affect the amount of tax payable by the employee and the NICs payable by the employer.
Records must be accurate and up to date, and must be kept for six years.
What is gross pay and how is it calculated?
Gross pay is the employee's total payment, before any deductions are made for PAYE, NICs and other agreed purposes (such as pension contributions or student loan repayments).
Gross pay is calculated on the basis of the gross rate of payment shown in the employee's statement or contract of employment. The calculation is made differently depending on whether the employee is being paid at an hourly rate or on an annual salary basis.
When employees are paid at an hourly rate, the payroll system must record the actual hours they work each day, particularly if they are entitled to overtime rates for any hours worked over their basic hours. For example, if an employee is paid £10 per hour and works their contracted 40 hours in a week, their gross pay for that week is £400. If they are entitled to overtime, say at 1.5 times the hourly rate, and work 44 hours the next week, their gross pay will be £460 for that week (ie £400 plus £60 overtime).
For employees paid an annual salary, it is usual to spread the payments equally throughout the year. Therefore an employee on a salary of £18,000 per annum will receive a gross monthly salary of £1,500. Adjustments may need to be made if an employee takes unpaid leave or starts or leaves employment part-way through a month. In these situations, adjustments to the monthly salary are made by calculating a day rate and deducting this as appropriate.
For example, if the employee works five days a week and has one day's unpaid leave in a month, the amount to be deducted can be calculated as follows: £18,000 divided by 52 weeks, divided by five working days = a day rate of £69.23. An hourly rate can be calculated by dividing the day rate by the normal number of working hours in a day. In this example, if the working day is 7.5 hours, the hourly rate would be £9.23.
What is net pay?
Net pay is the amount of money that the employee actually receives once income tax, NICs and any other agreed deductions have been taken from their gross pay.
To make a correct net payment to an employee, the basic steps are:
- Calculate the gross pay that is due.
- Determine whether any statutory payments, such as sick or maternity pay, are due and add these to the amount of gross pay.
- Calculate the income tax and NICs due and deduct from the gross pay.
- Make any other agreed deductions.
- Pay the net pay that is due.
- A record must be kept of all payments made to employees, with details of their gross pay and the deductions made.
What happens to the deductions?
Payroll software produces a standard monthly report, which details the breakdown of deductions for income tax, NICs and student loan repayments that are due to be paid to HMRC and any statutory payments, such as maternity pay, that are being reclaimed. They also calculate the amount of employer's NICs that must be paid.
The deductions and employer contributions that are made in one month need to be paid to HMRC. Online payments must be made by the 22nd day of the following month, but if payment is made by cheque, it must be received by the 19th. If an employer's total monthly payments are less than £1,500, they can opt to pay HMRC quarterly rather than monthly.
Pension contributions are another standard deduction from employees' pay and they must be paid to the pension provider by the 22nd of the following month (19th if payment is made by cheque).
What must be included on pay statements?
Employers must provide a written pay statement, known as a payslip, to everyone on the payroll, on or before the day that they are paid, setting out how their net pay has been calculated.
Payslips must show the following information:
- Earnings before and after any deductions.
- The amount of any deductions that may change each time the person is paid, for example tax and National Insurance. (Employers must also explain any fixed deductions, for example repayments of season ticket loans, but this information can be provided either on the payslip or in a separate document.)
- From 6 April 2019, if a worker's pay varies depending on the number of hours that they have worked, their payslips must show the number of hours worked during the payment period.
For more information about new requirements relating to payslips that came into force on 6 April 2019, go to www.gov.uk/government/publications/payslip-policy-a-guide-to-the-2019-legislation.
Employers who produce their own payslips can choose the layout that they use. Employers using payroll software that generates the payslips may be restricted to using the package's standard layout, although some packages allow modification. Payslips can be printed or provided electronically. If they are printed, it is customary to provide them in a sealed envelope with the employee's name on it, so that the information on the payslip remains confidential.
Operating an in-house payroll system
Employers must decide whether to operate a payroll system themselves (in-house) or use a bureau that provides a payroll service. There are several important issues to be considered by employers before deciding to operate a payroll system in-house:
Operating a system in-house gives control, but it also requires appropriate knowledge and time to run the system.
To establish whether it is actually cheaper to buy a payroll package than to use an outsourced service, an employer must take into account the cost of their own or their staff's time spent running the system. It is also important to consider how the system will be run when the staff managing it are absent through sickness or holiday leave.
Because there are changes every year to the PAYE system, employers running their own payroll system need to take out an annual licence for their payroll software to ensure that it is kept up to date.
How will employees be paid? Electronic payment, for example, via Bacs or Faster Payment, is the preferred method of payment for most employers and employees.
Using a payroll service
Most accountants and bookkeepers offer payroll services for small business clients. They can often provide a full package of services. There are also payroll bureaus that specialise in this type of service. Employers can usually specify the level of service that they require, which may range from receiving payslips and monthly deduction calculations to a complete payroll service that includes all standard payments and returns, as well as the calculation of expenses and benefits.
The cost of the service is a major consideration when comparing providers. Employers should check which parts of the service are included as standard within a monthly charge and which parts are chargeable as extra costs.
A particular advantage of using a payroll service is that many of the problems associated with resolving issues with HMRC are dealt with by the service provider and employers can be confident that the job is being done properly. But even when an outsourced payroll service is used, someone in-house will still have to liaise with the service provider, as they will need details of new employees, changes to pay rates and details of those leaving employment.
The employee information that is held within payroll records must comply with the General Data Protection Regulation (GDPR) and the Data Protection Act 2018. Employers must store employees' records securely and inform employees what data is kept about them and how it is used. Employees' consent must usually be obtained before using their personal data for anything other than meeting statutory record-keeping requirements.
Hints and tips
Employers must ensure that whoever operates their payroll system is aware of their requirements under data protection legislation.
Employees have the right to take employers to an employment tribunal if they are not provided with an itemised payslip.
If an employee leaves their employment and has not taken all of their accrued holiday entitlement, their employer must make a payment for the outstanding days of holiday due to them.