YOUR LEGAL OBLIGATIONS

If you employ any staff at all, you will need some system to record wages payments. You must by law deduct income tax and national insurance contributions from payments made to your employees where appropriate. You should contact the local Inspector of Taxes and ask him to set up a PAYE scheme for your business so that you can make the appropriate deductions and pay the tax and national insurance contributions to the Collector of Taxes as necessary. For 2006/2007 if your employee earns more than £97 per week from you, then you must deduct national insurance contributions. For a single person with no other employment, tax is payable when the earnings exceed approximately £97.00 per week. (The exact figure will depend upon his/her entitlement to personal taxation allowances.) Consideration should also be given to the National Minimum Wage regulations (see page 99.)

WORKING OUT THE WAGES

The steps for calculating wages are:

• calculate gross pay
• calculate deductions – income tax and national insurance
• calculate net pay.

Figure 30 shows it all in diagrammatic form.

Gross pay

The gross pay of an employee can be worked out in one of several ways. The most common methods are:

Fixed weekly or monthly amount

The employee works a set period each week/month and is paid at a fixed

rate each week/month. This is commonly the case for office and shop

workers.

At an agreed rate per hour

The employee keeps a record of the hours worked and is then paid at a fixed rate for each hour that they work. This system is common, for example, in engineering works. Normally the record is kept by means of a time clock (’clocking in and out’) but a manual system can work just as well in a smaller business.

At an agreed rate per unit (piece work)

The employee is paid for the number of items that they handle during the course of the week. An example might be a sewing machine operator in a garment factory. The employee might be paid l0p for each sleeve that they sew into a garment during a week. Normally the system works by using a numbered slip, consisting of a number of perforated tickets. Each ticket relates to a specific task; for example, cutting the fabric or sewing the garment. The slip is attached to the cloth as it is laid out for cutting; as it passes through the various processes each worker collects the appropriate ticket. At the end of the week the tickets held by each employee are counted and the wages calculated accordingly.

DEDUCTIONS FROM WAGES

Having calculated the gross pay entitlement, you next need to work out the deductions (stoppages) from each employee’s wage. There are two main deductions:

• income tax
• national insurance contributions. You may also need to deduct sums for trade union dues, sickness benefit schemes, pension scheme contributions, and so forth.

Income tax

Income tax is collected from employees through the PAYE system, or Pay As You Earn. The employee’s liability to income tax is collected as it is earned instead of by tax assessment at some later date.

Strictly speaking, PAYE is a method of tax collection, not tax assessment. However, in most cases the system collects roughly the right amount of tax. Accordingly the Inspector of Taxes does not normally need to raise a formal assessment of Income Tax, but will do if the amount collected through PAYE is substantially incorrect.

If a tax assessment is needed credit is given for the amounts already collected through the PAYE system.

From your viewpoint as an employer you must:

• Make the appropriate deductions of tax from your staff’s wages.
• Keep a suitable record of the amounts paid to your staff and the amounts deducted.
• Account to the Collector of Taxes for the amounts of tax due each month.
• Prepare the returns at the end of the tax year, detailing the payments made to each of your staff and showing the amounts deducted.

The documents you will need

The Inland Revenue now issue reasonably clear booklets explaining how PAYE works. The main documents you need to operate PAYE are:

• 1.A deduction working sheet (Form PI 1) for each employee.
• 2.The PAYE Tables. There are two books of tax tables in general use: Table A – Pay Adjustment Tables. Shows the amount that an employee can earn in any particular week or month before the payment of tax. Tables B to D and LR – Taxable Pay Tables. Show the tax due on an employee’s taxable pay.
• 3.Forms P45, P46 and P60. These forms are as follows: P45 is given to an employee when transferring from one employment to another. P46 is used when a new employee does not have a P45 from a previous employment (e.g. a school-leaver starting work for the first time). P60 is used so that the employer can certify an employee’s pay at the end of the income tax year in April.
• 4.Form P35 – The year end declaration and certificate. This is used to summarise all the tax and national insurance deductions from employees for the tax year.
• 5.The tax code advice (Form P6) – A notice issued by the Inspector of Taxes telling you which tax code number to use for each employee.

National insurance

As well as deducting income tax you must also deduct national insurance (NI) contributions. There are three main rates of contribution for NI purposes:

• Table A – The most common rate, used in all cases except those mentioned below.
• Table B – used for certain married women who can produce to you a certificate for payment at reduced rate.
• Table C – used for employees who are over pension age (60 for women, 65 for men).

For Tables A and B there are two aspects to the contributions: the employee’s contribution and the employer’s contribution. For Table C there is no employee’s contribution. The amounts of contributions are recorded on the same deduction working sheets as used for income tax purposes.

CALCULATING DEDUCTIONS AND NET PAY

We have looked at the calculation of gross pay and the fact that there are at least two deductions from gross pay – income tax and national insurance. How do you calculate them?

Income tax

Figure 31 shows how the tax deduction is worked out. The steps are as follows:

• 1.Add this week’s gross pay to the previous total of gross pay to date, so as to show the total gross pay up to and including this week of the tax year.
• 2.By checking the tax code number of the employee and Table A arrive at the figure of tax-free pay for that particular week.
• 3.Deduct the amount of tax-free pay from the total pay to date, to get the amount of taxable pay.
• 4.By using Table B (which is actually a 22% ready reckoner) work out the tax due on the total taxable pay for the year to date. Then make the appropriate deduction to allow for the tax due at the starting rate.

• 5.Deduct the amount of tax already accounted for in previous weeks, from the total tax due, to work out the tax due for the week.

If the pay interval is monthly then the method outlined above needs to be adapted to months, not weeks.

Special tax codes

While this system covers most cases it does need modification in the

case of certain tax codes:

• Those with a suffix D – used for some higher rate tax payers.
• Those which are BR – all income is taxed at basic rate (currently 22%).
• Those with a prefix K – used when allowance restrictions exceed available tax allowances.

Check the PAYE literature for guidance in these cases. There are two other cases where some modification is necessary:

• Where the code number is suffixed ‘Week 1’. In this instance calculate each week as if it was the first week of the tax year. Do not use the accumulated figures of gross pay, or tax paid to date.
• Where the income of the individual is such that they must pay tax at above or below the basic rate. The limits at which higher or starting rates of tax come into force are shown in the Taxable Pay Tables. Refer to the PAYE booklets for guidance if necessary.

National insurance

Normally, both employer and employee have to make NI contributions. The amounts of NI due are found by referring to the appropriate table. The tables show both the employee’s liability and also the total liability for the week or month. Both these figures must be recorded on the deduction working sheet.

Net pay

The net pay is worked out by simply deducting the employee’s income tax liability and NI contributions from the gross pay worked out before.

Note: it is only the employee’s share of NI liability that should be deducted, not the total.

Payslips

The Employment Protection (Consolidation) Act 1978 means that employers must provide their staff with itemised pay statements. These must show:

• gross pay
• net pay
• any deductions (stating the amounts of each item and the reason why the deductions are made).

WHAT ACCOUNTING RECORDS WILL I NEED?

When you pay out wages and salaries to your staff you need to record the net pay in your cash book. This will also record the PAYE and NI paid to the Collector of Taxes.

If you only have one or two employees then the record of the payments in the cash book, together with the other PAYE documentation, will probably do. But if you have any more, it won’t! The deductions working sheet gives you a record of the payments made to each employee throughout the year. You also need a summary of the payments made to all employees on one particular date. You should therefore keep a simple wages book as shown in Figure 32. You can buy books like this from most stationers. The book uses a set of columns to record the following:

• gross pay for the week
• the tax deduction from each employee’s wages for the week
• the NI deduction for each employee for the week
• the total deductions from employee’s wages
• the amounts of the net payments made to the employees for the week
• the total NI contributions due for each employee.

Add the columns up to give the total for each category for the week.

In a full double entry bookkeeping system you’ll need to transfer these totals into your nominal ledger. If you want to check the value of the NI contributions that you are paying as an employer, just deduct the employee’s contributions from the total NI contributions (£214.86 £95.03= £119.83 in the example).

OWNERS AND DIRECTORS

Proprietor’s drawings (sole traders and partnerships)

Sometimes confusion can arise if the proprietor believes that his weekly drawings are his wage. He is tempted to enter the figures in his wages book and may even try to operate PAYE on his income. Beware! – this is wrong. Proprietor’s drawings are not wages and should not be entered in the wages book.

Directors

If the business is carried on by a limited company then the directors of the company are employees. PAYE must be operated on all salaries and bonuses paid to them.

National Minimum Wage

There are now National Minimum Wage rates for employees and action can be taken against employers who pay less than the prescribed rate. The rates are:

	From 1 October 2005	From 1 October 2006
Adult rate (workers aged 22+)	£5.05	£5.35
Development rate (18 to 21 year olds)	£4.25	£4.45
Youth rate* (16 and 17 year olds)	£3.00	£3.30

*this applies to 16 year olds who are no longer of compulsory school age

For more details contact the National Minimum Wage Helpline on 0845 6000 678 or look at the web site at www.dti.gov.uk/employment/pay/national-minimum-wage/index.html

SUMMARY

• You must deduct tax and national insurance from your employees. There are severe penalties if you fail to make the deductions.
• You must then account for the sums deducted to the Collector of Taxes each month – full instructions on this are given in the PAYE documentation.
• You need to instigate a suitable system for calculating the amount of pay that each employee is entitled to, whether it is on a time basis or on a piece work system etc.
• If you have several employees then you should keep a wages book to record the wages that you pay to your employees.
• The drawings of the proprietor are not wages.
• PAYE must be operated on directors’ salaries.
• Make sure you pay at least the National Minimum Wage rates.