Taking on employee(s) for the first time is an exciting step, and a notable success marker, for any small business in the UK. As it confirms that you’ve managed to grow your business to a level where you can begin expanding your team.

This is a day to remember. Your hard work so far has paid off and demand for your services is clearly there, so take a moment to give yourself a pat on the back!

With that growth, however, comes the responsibility of setting up and running payroll – an essential process required for your team to be paid accurately and on time, while also meeting your legal obligations with HMRC.

The basics of UK payroll

Payroll is the system you'll use to manage the financial relationship with your employees. It encompasses everything from calculating their earnings and deducting the correct Income taxes, National Insurance contributions, Student or Postgraduate Loans, pensions amongst others to actually paying them and reporting this information to HM Revenue & Customs (HMRC) and other third parties.

Here are some fundamental terms and principles you'll encounter when setting up payroll in the UK:

• National Insurance (NI) contributions - These are payments made by both employees and employers to fund benefits like the State Pension and unemployment benefits. The amount depends on an employee's earnings and specific NI categories. As an employer, you'll be responsible for deducting your employees' NI contributions and also paying your own employer contributions.
  
  
• Income tax - This is the system HMRC uses to collect Income Tax through payroll. As an employer, you'll need to deduct Income Tax from your employees' wages based on their individual tax code and pay it to HMRC.
  
  
• Tax codes - These are issued by HMRC to your employees and tell you how much tax-free income they are entitled to before Income Tax is deducted. Employees will typically provide their tax code on their P45 form (from a previous employer) or you'll need to use a starter checklist to determine the initial tax code until HMRC provides one.
  
  
• Gross pay vs. Net pay - Gross pay is the total amount an employee earns before any deductions are made (e.g., hourly rate multiplied by hours worked, or their salary divided by the pay period). Net pay is the amount the employee actually receives after all deductions (tax, National Insurance, pension contributions, etc.) have been taken out.
  
  
• Payslips - These are legally required documents you must provide to your employees each time they are paid. They detail their gross pay, all deductions, and their net pay for that pay period.
  
  
• Pension contributions (Auto-Enrolment Overview) - In the UK, employers have a legal duty to automatically enrol eligible employees into a workplace pension scheme and contribute towards it. While the full details of auto-enrolment are beyond the scope of this initial section, it's an important aspect of payroll that you'll need to address as you set up your system.
  
  
• Compliance with HMRC regulations - Payroll in the UK is heavily regulated. Accurate calculations, timely payments to employees, and correct reporting to HMRC are legal requirements. Failure to comply can result in penalties.

{{ltd-guide}}

Essential preparatory steps before your first pay run

Before you can start thinking about calculating wages and deductions, there are several key administrative tasks you need to complete, which are fundamental to legally and correctly setting up payroll for your small business in the UK.

Step 1 - Registering as an employer with HMRC

The very first thing you must do is register as an employer with HMRC. You need to do this as soon as you become an employer, even if you haven't paid anyone yet. You can register online through the government's website via the Government Gateway.

During the registration process, you'll need to provide information about your business, such as:

• Your business name and address
• Your Companies House registration number (if you're a limited company) or your Self Assessment Unique Taxpayer Reference (UTR) if you're a sole trader or partnership.
• The date you became an employer.
• Details about your business activities.
• Contact details for your business.

Once your registration is complete, HMRC will send you an Employer PAYE reference number. This is a unique identifier that you'll need to use in all your communications with HMRC regarding payroll. Keep this number safe and readily accessible.

Step 2 - Choosing a payroll method

Once registered, you'll need to decide how you're going to manage your payroll. For small businesses setting up payroll for the first time, there are typically three main options to consider:

• Manual payroll (using spreadsheets) - This involves manually calculating wages, deductions, and keeping records using spreadsheets. While it might seem like the cheapest option initially, it can become very time-consuming and prone to errors, especially as your number of employees grows or if payroll rules become more complex. It's generally not recommended for more than a very small number of employees due to the risk of non-compliance and mistakes.
  
  
• Payroll software - This is a popular choice for many small businesses. Payroll software automates many of the calculations, record-keeping, and reporting tasks. It can help ensure accuracy and compliance with HMRC regulations. There are various software packages available, ranging in price and features. Consider factors like the number of employees, ease of use, integration with other accounting software, and customer support when making your decision.
  
  
• Outsourcing to a payroll bureau - If you'd prefer to hand over all payroll responsibilities to experts, you can outsource your payroll to a specialist payroll bureau or accountant. They will manage everything from calculations and payments to reporting to HMRC. This can save you time and reduce the burden of staying up-to-date with changing regulations, but it will come with ongoing costs. This can be a particularly good option if you have limited administrative resources or prefer to focus entirely on your core business activities.
  

Think carefully about the size of your business, your budget, your level of payroll knowledge, and the time you have available when choosing a payroll method.

Step 3 - Gathering employee information

Before you can pay your first employee, you'll need to collect some essential information from them. This information is needed for accurate payroll processing and legal compliance. Make sure to obtain the following details for each employee:

• Full name and address: For identification and record-keeping.
• Date of birth: For National Insurance purposes.
• National Insurance number: This is unique to each individual and is required for accurate tax and NI calculations. You should ask your employees to provide this.
• Tax code: New employees should ideally provide you with their P45 form from their previous employer. If they don't have one, you'll need to use HMRC's starter checklist to determine their initial tax code until HMRC provides you with one.
• Bank account details: For paying their wages directly into their account. Ensure you have the correct account name, sort code, and account number.
• Details for any deductions: This might include information for student loan repayments, pension contributions (once your auto-enrolment duties begin), or any other agreed-upon deductions.

Once you have gathered all this information accurately and securely, you'll be ready to move on to the process of running your first payroll.

{{cta-limited-company}}

Ongoing payroll responsibilities

Setting up payroll is just the beginning. Once you're up and running, there are several ongoing responsibilities you'll need to manage for continued compliance and smooth payroll operations.

• Maintaining accurate payroll records - You are legally required to keep detailed payroll records for at least three years from the end of the tax year they relate to. This includes information about employees' pay, deductions, tax codes, payments to HMRC, and any other relevant payroll data.
  
  
• Dealing with leavers (P45 Process) - When an employee leaves your employment, you need to provide them with a P45 form. This form details their pay and tax for the tax year up to their leaving date. You also need to submit details of their leaving date and final pay to HMRC via an FPS.
  
  
• Payroll Year-end procedures - At the end of each tax year (5th April), you'll have specific reporting requirements to HMRC. This typically involves submitting final payroll information for the year. Your payroll software will usually guide you through these processes.
  
  
• Auto-Enrolment pension scheme duties - If you haven't already, you'll need to fulfil your auto-enrolment pension scheme duties. This includes assessing eligible employees, automatically enrolling them into a pension scheme, and making employer contributions. You'll also need to handle ongoing tasks like managing opt-outs and processing contributions through your payroll.
  
  
• Staying updated on legislation and HMRC guidance - Stay informed about any updates from HMRC regarding tax codes, National Insurance rates, employment law, and other relevant legislation in order for your payroll processes to remain compliant. HMRC's website is a key resource for this information.

Payroll sorted

Successfully setting up payroll in the UK for your small business hinges on accurate employer registration with HMRC, choosing a compliant payroll method, meticulous employee data collection, precise calculation of pay and deductions, and timely reporting through RTI. 

Remember to prioritise ongoing record-keeping and stay informed about evolving regulations, so you’ll remain compliant. We’ll leave with this list of tips, and things to get right so you can make setting up payroll as easy and stress free as possible:

• Choose the right payroll software early
• Accurate employee data is key
• Understand HMRC's resources
• Establish clear pay schedules and policies
• Seek Professional advice if needed
• Stay updated on legislation
• Regularly back up your payroll data
• Double-check before processing

If, after reading this guide, payroll sounds like something you need professional help with, then reach out to Crunch. We’ve helped thousands of businesses optimise their payroll to be super tax and time efficient, and our friendly team of expert accountants can do the same for you.

‍