What is Pay as You Earn (PAYE)?

If you’re using an umbrella company for your payroll, or you’re considering it, you should already know what Pay as You Earn (PAYE) is. However, if you’re not, or you’d like a friendly reminder – keep reading! We’ll cover the basics.

What is PAYE?

Pay as You Earn, or usually just ‘PAYE’ is a tax system introduced by HMRC to help employees pay the correct, legal amount of tax and National Insurance Contributions (NIC). PAYE is processed by the employer, and the employer is responsible for deducting the right amounts of income tax and NICs (to the gross salary) for each of its employees. These deductions are sent straight to HMRC. Once the deductions have been made, employees are paid their net salary.

The employer may be required to deduct additional amounts, depending on the individual’s personal circumstances. These additional deductions may include pension contributions and student loan repayments.

At the end of the tax year, employees are issued with a P60 document. This will outline their earnings for the previous 12 months, and will clearly highlight all of the deductions that have been sent to HMRC.

PAYE and umbrella companies

Umbrella companies exist to process the payroll of contractors and freelancers in accordance with HMRC rules and regulations. Just like an employee in permanent employment, umbrella employees are taxed in accordance with PAYE.

By joining an umbrella company, you become an employee of theirs. You are free to work on your temporary assignments as you please, but it’s vital you submit timesheets to your agency/client and umbrella to ensure you’re paid on time. Your agency or client will then send your gross salary (before any deductions are made) to your umbrella company, because it’ll be the umbrella company who actually goes ahead and pays you. The umbrella company will then make the appropriate deductions to your salary (PAYE) and will pay you accordingly. It really is that simple.

The only responsibility for compliant umbrella companies is to process the payroll of their employees. The only income the umbrella generates for itself is the margin they deduct each time they pay someone. Every other deduction is paid to HMRC.

Upcoming changes to off-payroll in the private sector (IR35)

Changes to off-payroll in the private sector (IR35) are coming in April 2021. We’ve already seen a number of contractors who have traditionally operated through a personal service company be told they need to use an umbrella (because they’re inside IR35). We appreciate that if you are new to umbrella companies, the idea of receiving PAYE is not appealing compared to paying yourselves with a combination of dividends and salary. However, we’re hoping end-clients engaging with temporary workers make fair IR35 assessment and that genuine contractors are able to continue benefiting from operating through their limited companies.

If you do find yourself inside IR35 moving forward, we recommend using an umbrella company for your payroll. Not only do they do a majority of the administration, you’ll also be able to take advantage of a load of extras, including Employee Benefits, free insurance cover, and more.

If an umbrella is offering something different to Pay as You Earn – run away because they’re a tax avoidance scheme

Tax avoidance schemes exist to take advantages of loopholes in UK tax law. As a result, they’re usually offering contractors and freelancers the chance to retain more of their money, and to pay less tax and National Insurance Contributions. Whether you like paying tax and NIC, you are ethically entitled to pay your way. Therefore, if an umbrella is encouraging you otherwise – you shouldn’t be tempted.

Engaging with tax avoidance schemes can often have devastating consequences. And, if you use one now and then decide to stop – did you know you could be retrospectively held accountable? That’s right – even if 10 years pass, you’re not out of the woods because you could still be subjected to an HMRC investigation down the line. If you’re found to have avoided your fair share of tax, HMRC will hold you accountable and you could face a life-changing fine.

We’ve recently published a blog about the new scandal that is mini umbrella companies (MUC). We recommend you check it out.

Use an umbrella company you can trust

We cannot stress this enough – only use a compliant umbrella company for your payroll! Compliant umbrella companies process their payroll in accordance with the HMRC tax system – Pay as You Earn (PAYE). And, as a result, it means you’ll pay the appropriate tax and National Insurance Contributions to HMRC, and you’ll never face an unexpected tax investigation in the future.

To help make your life easier, we’ve collated a list of top 10 umbrella companies. Every top 10 umbrella company is accredited by the FCSA – the UK’s leading professional body dedicated to ensuring the supply chain of temporary workers is compliant with UK tax law. And, some of them have some awesome offers on at the moment!

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