What is PAYE?

Who Needs to Operate a PAYE Scheme? What Small Business Owners Need to Know

PAYE stands for Pay As You Earn.

It is HMRC’s system for collecting Income Tax and National Insurance from employment income. PAYE is not a separate tax. It is the way employers calculate, deduct, report and pay employment taxes to HMRC through payroll.

For small limited company owners, PAYE is especially important because a limited company is a separate legal entity. The money earned by the company belongs to the company, not personally to the director or shareholder.

If you want to take money from the company as salary, it must be dealt with properly through payroll.

How does PAYE work?

Each time an employee or director is paid, the payroll process normally:

1. Calculates the gross salary.

2. Applies the employee’s tax code.

3. Applies the correct National Insurance category.

4. Deducts Income Tax, employee National Insurance, student loan deductions and pension contributions where relevant.

5. Pays the remaining amount to the employee. This is called net pay.

6. Reports the pay and deductions to HMRC.

If you run payroll yourself, HMRC says you must report employees’ payments and deductions on or before each payday. This is normally done through a Full Payment Submission, known as an FPS.

Simple PAYE example:

An employee has a gross monthly salary of £2,000.

Payroll calculates the deductions due, such as Income Tax, employee National Insurance and any student loan or pension deductions.

The employee receives the amount left after those deductions.

The employer then pays HMRC:

• the Income Tax deducted from the employee;

• the employee’s National Insurance deducted from their pay;

• any employer’s National Insurance due;

• and any student loan deductions.

Employer’s National Insurance is an extra cost for the employer. It is not deducted from the employee’s salary.

When does a business need to register for PAYE?

You must register for PAYE if any of the following applies to an employee in the current tax year:

• they are paid £96 or more per week;

• they receive expenses or company benefits;

• they receive a pension;

• they have had another job;

• or they have received Jobseeker’s Allowance, Employment and Support Allowance or Incapacity Benefit.

HMRC also says you must register as an employer even if you are only employing yourself, for example as the only director of a limited company. You must register before the first payday, and you cannot register more than two months before you start paying people.

What does an employer need to do?

If your company operates PAYE, it will normally need to:

• register as an employer with HMRC;

• choose payroll software;

• keep payroll records;

• tell HMRC about employees and directors paid through payroll;

• calculate pay and deductions;

• submit payroll reports to HMRC on or before payday;

• pay HMRC the PAYE and National Insurance due;

• and complete any end-of-year payroll tasks.

HMRC’s payroll guidance confirms that employers need payroll software to record employee details, calculate pay and deductions, and report to HMRC.

Payroll records must be kept for three years from the end of the tax year they relate to. HMRC can check these records to make sure the right amount of tax has been paid.

When is PAYE paid to HMRC?

PAYE is normally paid monthly.

If you pay electronically, the deadline is usually the 22nd of the next tax month. If you are allowed to pay quarterly, the deadline is normally the 22nd after the end of the quarter. If paying by post, HMRC must receive the payment by the 19th.

Small employers who usually pay less than £1,500 per month may be able to pay quarterly instead of monthly, but this should be arranged with HMRC.

Why PAYE matters for limited company directors

A limited company owner can usually extract money from the company in different ways, including:

• salary;

• dividends;

• repayment of money previously lent to the company;

• reimbursement of business expenses;

• or, in some cases, a director’s loan.

These are not the same thing.

A salary is payment for work done for the company. It is normally processed through PAYE and, subject to the usual rules, can be an allowable company expense.

A dividend is a distribution of company profits to shareholders. It is not a business expense and does not reduce the company’s Corporation Tax bill.

This is why many small limited company directors use a mixture of salary and dividends as part of their profit extraction strategy.

But the salary part must be processed correctly.

A salary must be reported as salary

A payment cannot simply be called “salary” after the event if it has not been processed through payroll.

If money is taken from the company and it has not been:

• processed as salary through PAYE;

• declared as a dividend;

• reimbursed as a genuine business expense;

• or repaid as money the director previously lent to the company;

then it will usually need to be recorded through the director’s loan account.

Director’s loan accounts have their own tax rules and can create additional tax charges if they are overdrawn and not cleared correctly.

Key 2026/27 PAYE and National Insurance thresholds

For 2026/27, the standard Personal Allowance and the Primary Threshold for employee National Insurance is £12,570 per year.

The Secondary Threshold is the point where employers start paying employer Class 1 National Insurance. For 2026/27, this is £5,000 per year, or £96 per week.

The employer Class 1 National Insurance rate for employees and directors is 15% above the Secondary Threshold.

This means a director can have no personal Income Tax or employee National Insurance on a salary of £12,570, assuming they have the standard tax code and no other employment income affecting the code. But the company may still have employer National Insurance to pay on earnings above £5,000.

Example:

John is the owner and sole director of his limited company.

For 2026/27, he plans to take:

• director’s salary: £12,570;

• dividends: £37,700.

The company must operate a PAYE scheme to pay John this salary.

Assuming John has the standard Personal Allowance, no other PAYE income and a normal National Insurance category, he should not personally pay Income Tax or employee National Insurance on the £12,570 salary.

However, the company will pay employer National Insurance because the salary is above the Secondary Threshold.

The calculation is:

£12,570 – £5,000 = £7,570

£7,570 × 15% = £1,135.50

So the employer National Insurance due is £1,135.50.

The salary of £12,570 and employer National Insurance of £1,135.50 will normally be allowable company costs, provided they are properly processed and recorded.

What about Employment Allowance?

Some employers can reduce their employer National Insurance bill by claiming Employment Allowance.

For 2026/27, Employment Allowance is £10,500 for eligible employers.

However, a company with only one director cannot claim Employment Allowance if that director is the only employee liable for secondary Class 1 National Insurance.

This means many one-director companies cannot use Employment Allowance to cover the employer National Insurance on the director’s salary.

The position can be different where the company has other employees or more than one director paid above the Secondary Threshold.

What happens if you do not operate PAYE correctly?

If a company pays salary but does not report it correctly through payroll, this can create problems.

The company may have:

• late payroll submissions;

• unpaid PAYE or National Insurance;

• interest and penalties;

• incorrect accounts;

• incorrect director’s loan account balances;

• and problems when preparing Self Assessment tax returns.

Common PAYE mistakes small companies make

The most common mistakes include:

• paying a director without setting up PAYE;

• assuming a salary can be recorded once a year without payroll reports;

• confusing salary with dividends;

• forgetting employer National Insurance;

• assuming the Personal Allowance applies to the company;

• missing FPS filing deadlines;

• not keeping payroll records;

• ignoring PAYE because there is only one director;

• not checking whether Employment Allowance is available;

• and treating drawings as salary when they should be posted to the director’s loan account.

Key point for small business owners

The Personal Allowance belongs to the individual. It does not belong to the company.

The Secondary Threshold applies to the employer. This is the point where the company starts paying employer National Insurance.

So, a director salary of £12,570 may be tax efficient in some cases, but it is not “free” for the company if employer National Insurance is due.

The company must operate PAYE properly, file the payroll submissions and pay HMRC on time.

Final thoughts

PAYE is one of the basic compliance areas that every small company owner should understand.

It affects how directors are paid, how employees are paid, how tax is reported, and how much the company owes to HMRC.

A salary can be tax efficient because it may reduce company profits for Corporation Tax purposes.

But it must be real salary, processed through payroll and reported to HMRC correctly.

The key question is not just:

“How much salary should I take?”

The better question is:

“Has the salary been processed correctly through PAYE, and have the tax consequences been planned properly?”

At Busy Bee, we help small limited company owners stay compliant, tax efficient and in control of their business finances.

We can help you understand how PAYE fits into your wider profit extraction plan, alongside dividends, pensions, tax-free benefits and director’s loan account planning.

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Disclaimer: The content on this page is for general information only and should not be treated as tax, legal or financial advice. Tax planning should always be reviewed against your individual circumstances before action is taken.