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PAYE (or pay-as-you-earn) is a payroll deduction system for collecting income tax in the United Kingdom. Under the PAYE system, tax being deducted (or withheld) from a person's income by their employer as they earn it. The amount withheld is usually determined by a tax code which encapsulates the taxpayers individual tax allowances. The PAYE system is also used to collect national insurance contributions.
PAYE is intended to collect the correct amount of tax on an employee's pay automatically, so no tax return and no further payment of tax is required. However, where necessary, the taxpayer and government reconcile the difference between the amount withheld and the amount owed by the filing of a tax return (for example, where the employee has other income, such as interest or dividends, which is not fully taxed at source).
PAYE allows most income tax payable by the large number of employees to be collected readily and easily from a smaller number of employers, with a minimal compliance obligation for the employee. If PAYE did not exist, each individual taxpayer would need to make their own tax payments. In the past, this meant that tax has gone unpaid or paid late because the taxpayer has spent the money instead of saving it for their tax payments. The cost of administering a large number of relatively small payments from individuals compared to a lot fewer larger ones from employers means that PAYE is administratively attractive. However employers are subject to a compliance cost as they have to administer the PAYE deductions on behalf of the government, and employers are also potentially liable for penalties and interest if the amount paid to the Inland Revenue is too small.
The PAYE system was introduced in the UK in 1944, following trials in 1940-1.
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