Small business guide to payroll

24th June 2019

As a responsible business owner in the UK, you are legally obligated to compensate your employees regularly and fairly. However, it is not enough that you just pay them every month. You are also required by law to run payroll.

What is Payroll?

Payroll is a process that includes accounting for payments and deductions, providing payslips, making records of these figures and calculations, reporting pay and paying HM Revenue and Customs (HMRC) its due, as well as sending contributions to pension providers if need be.

Part of calculating deductions is PAYE or Pay As You Earn. PAYE is how HMRC collects Income Tax and National Insurance from employees. If none of your employees is paid £118 or more a week, get expenses and benefits, have another job, or get a pension, PAYE isn’t required.

Before you can start running payroll for your employees, here are the things you need to get done:

  • Register as an employer with HMRC — This has to be done before the first payday, but you cannot register more than two months before the first payday. It takes up to five days before you get your PAYE number. You still need to register even if you’re only employing yourself.
  • Get Employers’ Liability (EL) insurance — The insurance policy has to come from an authorised insurer, and it should cover at least £5 million for illness or injury worker compensation claims. You can incur a £2,500 fine every day if you do not provide EL insurance, and a £1,000 fine if you don’t have your EL certificate on display. You are not required to get EL insurance if you only employ a family member or a person based abroad.
  • Set up a workplace pension scheme— All employees aged between 22 and State Pension Age, earn at least £10,000 annually, and are based in the UK (including those who travel to work) must be enrolled in a pension scheme. Employees are free to opt out. Your minimum contribution as an employer is 3%, while an employee’s is 5%. Non-compliance can result in a fine of up to £5,000.

The Payroll Process

There are two ways you can go about running payroll: enlisting the services of a payroll provider or doing payroll yourself.

Paying a payroll provider is convenient and lets you focus on operations. However, it is an additional cost, and it is to your benefit that you become familiar with how payroll works. Additionally, it is not the provider that will face legal consequences should your business fail to meet PAYE requirements.

Running Payroll Yourself

If you choose to do payroll yourself, you have to finish the following tasks on or before payday:

  • Record employee pay details
  • Account for deductions
  • Create payslips
  • Calculate your National Insurance contribution
  • Submit reports to HMRC

All these tasks can be done via payroll software.

There are two types of payroll software you can use: free and paid software. If your company employs fewer than 10 people, free payroll software should be good enough. For more than 10 employees, it is recommended that you use paid payroll software.

HMRC has a list for free payroll software and another list for paid payroll software that it has tested and approved for use (which obviously contains Xero).

1. Calculating Employee Pay and Deductions

The payments you include in your calculation of your employee’s gross pay are as follows:

  • Salary
  • Statutory Pay
    • Statutory Sick Pay
    • Maternity, paternity, adoption, or shared parental pay
  • Tips paid through your till (customers’ card or cheque payments)

Expenses and benefits are reported at the end of a tax year instead of every payday.

Business expenses you need to reimburse are not subject to deductions, while personal expenses are taxable.

Benefits in kind such as a company car or private medical insurance may be subject to tax. You can refer to the government’s list of expenses and benefits, as tax rules differ on a case-to-case basis.

The deductions you must make to calculate for your employee’s net pay include:

  • Income tax
  • Employee National Insurance Contribution

The income tax is calculated through the employee’s tax code. HMRC provides this tax code or your employee’s previous employer can give you the code through the P45 form. Input this into your payroll software to get exactly how much you need to deduct for income tax.

Employees hired midway through a tax year should have their earnings and tax deductions on record from their previous employers. You need to include all this information as well into your payroll software to get accurate calculations for the end of the tax year.

For employees, the National Insurance contribution depends on what class they fall under: 1, 1A, or 1B. Your payroll software should calculate the rate for you, but the government has provided tables that give specific contribution rates for your reference.

Other payments that can be included in the deductions are:

  • Student loan contributions if applicable
  • Pension contributions for eligible employees
  • Payroll Giving donations
  • Child maintenance

2. Providing Payslips

The law mandates that you provide a payslip to your employees on or before payday. It can be printed or sent to employees digitally. The payslip should have the following details:

  • Gross pay
  • Deductions specified separately such as income tax, National Insurance, etc.
  • Net pay
  • Number of hours worked if pay is based on an hourly rate

3. Reporting to HMRC

The figures you have calculated for all of your employees’ pay should then be reported to HMRC as a Full Payment Submission (FPS).

Even employees who are paid less than £118 a week must be in the FPS. An FPS needs to be submitted on or before payday, even if you are paying HMRC quarterly instead of monthly.

To submit an FPS, input your PAYE reference and Accounts Office reference numbers provided by HMRC into your payroll software. Follow the instructions to complete the submission process.

You can send an FPS early, but any changes such as an employee leaving or changing their tax code must be reported with a corrected FPS.

An FPS cannot be submitted for the new tax year before March. Meanwhile, a late report results in getting a notice from HMRC. Without a valid reason for a late report, businesses with nine or fewer employees may get fined £100 a month for every late report. Businesses with 250 or more employees can be fined for as much as £400.

Running payroll yourself generally means you have to submit reports to HMRC online through your payroll software.

Exceptions can be made for the following reasons:

  • You can’t send reports online because you’re disabled, elderly, or have no internet access
  • You get care or support services for yourself or a family member
  • You can’t use a computer on religious grounds

4. Paying HMRC

The deductions you’ve calculated from every employee and reported on your monthly FPS must then be paid to HMRC every month.

Payment must be made by the 22nd of the month, or the 19th if you are paying by post. If you are paying less than £1,500 a month, you can choose to pay HMRC quarterly instead by contacting the government’s payment helpline.

You can check your submitted FPS for the previous tax month through your HMRC online account. This is helpful if you need reminding of much you owe HMRC. Failure to pay on time or in full results in financial penalties with interest.

There are a number of ways you can pay HMRC its dues. Depending on your chosen method, HMRC will receive the pay after a set period of time:

Online or telephone banking via Faster Payments or CHAPS is processed on the same day or the next day. Payment done through Bacs takes three working days. Bank details are as follows:

  • 08 32 10 for the sort code
  • 2001039 for the account number
  • HMRC Cumbernauld for the account name

Corporate credit or debit card payment can be done online through the PAYE portal and takes three working days. There is a non-refundable fee for payments via corporate credit.

Direct debit payment can be made through your HMRC online account. It takes five working days for the payment to be processed if you have just set up payment for the first time. Succeeding payments with the same bank details have a processing time of three working days.

Bank or building society payments are to be made payable to ‘HM Revenue and Customs only’ and should have your 13-character Accounts Office reference. This takes three working days. You need to use a payslip for the correct period or with HMRC’s payment booklet.

Cheque by post payments can only be made if your business employs fewer than 250 people. Processing takes three working days. You do need to include your 13-character Accounts Office reference and a payslip for the correct period or a replacement payslip. You can also use HMRC’s payment booklet in lieu of a payslip.

5. Updating HMRC on Employee Changes

Your FPS should include updates if an employee:

  • Is hired
  • Leaves
  • Becomes a director
  • Reaches State Pension age
  • Starts getting paid a workplace pension
  • Opts in or out of a contracted-out company pension
  • Works abroad
  • Goes on jury service
  • Turns 16
  • Gets called up as a reservist
  • Changes gender
  • Changes their address
  • Dies

If an employee takes a leave of absence, put ‘Yes’ in the ‘Irregular payment pattern indicator’ in all FPS reports until the employee returns.

6. Keeping Records

To ensure that you have been paying exactly what HMRC is due, you need to keep records of the following items:

  • Employee pay and deductions
  • Taxable expenses and benefits
  • Reports and payments to HMRC
  • Employee leaves and sickness absences
  • Tax code changes
  • Payroll Giving Scheme files
    • Agency contract
    • Employee authorisation forms

The figures need to match what you have reported. You also have to keep these records for three years from the end of their corresponding tax year. Incomplete records can result in HMRC making estimates and fining you up to £3,000.

In case of lost records that you can’t replace, recreate them as best as you can and contact HMRC immediately. Your final FPS of the tax year should indicate figures that are provisional, to be updated with actual figures, and estimated, which you want HMRC to accept as final.

Running payroll involves a lot of processes that can take up valuable time. If you need help with lessening the weight of this task so you can focus on your business, get in touch with our team of professional accountants.