8.1 Introduction
In this module, we will focus more on the 'take-home pay'.
Net pay is calculated after deductions from the gross pay. Some of these
deductions are mandatory and some are voluntary, where an employer is
instructed to deduct these additional amounts from pay by the employee. There
are strict guidelines in place for such matters, ensuring that the correct
deductions are made by the employer and also reported to HMRC. It is important
to get these deductions right, to avoid mistakes and confusion.
Let's reiterate the difference between gross and net pay, to refresh your
memory.
It is worthwhile going over this quickly again because it is so
important in terms of understanding the basics of a payroll system.
In our last module, we explained what gross pay is and how to calculate
it, and we explained what net pay is and how you reach the final figure at the
bottom of an employee's payslip. There are, of course, anomalies to take into
account, which will arise throughout the lifespan of your payroll system, and
these should be discussed and reviewed as they arrive; putting into place
mechanisms to address them in the future.
To sum up, gross pay is, as we have
discussed, the number of hours worked by the employee across that week or month
(depending on pay frequency), multiplied by the hourly rate they receive.
Remember that if you work in a large organisation, the hourly rate could be
different for every single employee, especially if the company operates an
incremental system, with employees rising up a scale on the wage system every
year.
Gross pay can also be described as
the yearly salary divided by the months; however, this is a loose description,
because if an employee works overtime, then this is included in the gross pay
and calculated at the overtime rate. The overtime rate needs to be communicated
to the employee at the time they commence employment with the company, and be
stated clearly in their contract of employment. Sometimes, employees are only
entitled to this rate if they work full time, i.e. part-time employees are paid
at a flat rate; again, this is an anomaly which needs to be clear at the time
of employment, to eradicate confusion.
On the other hand, net pay is the
amount of cash an employee is paid in their wage for that particular week or
month after all deductions have been made. This is the amount of pay they are
left with and is the amount at the bottom of their payslip i.e. the amount
which is paid into their bank account.
Deductions from gross pay are what
create net pay, and can be for a wide variety of different reasons, but the
main two are obviously tax and National Insurance.
This is why HMRC keep such a tight
rein on wage deductions - to ensure that the correct amount of income tax and
National Insurance is paid by each individual in employment, and this is
reported to HMRC by the full payment submission (FPS) that is created
automatically by your payroll software.
8.2 Voluntary Deductions
There are two categories of
deductions which may be taken from an employee's wages, with the first one
being voluntary deductions.
This is perhaps the most complicated
of deduction types because there are many reasons an employee may ask for a
deduction to be made and different categories that the deduction could fall
under. As the name suggests, voluntary deductions are, in essence, voluntary.
That means they don't have to be taken from an employee's wage
by law, but instead they are desired to be taken by the employee with their
permission.
To reiterate, voluntary deductions
are not required by law. For example, they may be healthcare contributions in a
private scheme which is deducted from wages for ease, parking costs which the
employee decides to pay at their place of work, or trade union contribution
costs. The list can vary and is personal and specific to that employee.
Whilst it is up to the employee to
inform the employer that they wish these deductions to be taken from their
wages, this must be done in writing; to give the employer permission to enter
these into the payroll system and for the deductions to automatically be taken.
The employee also has to give the employer adequate notice, to ensure that the
deduction is taken from the next full payment submission to HMRC and for the
correct wage amount to be generated.
If this does not happen then there
could be a delay in the first deduction being taken. Thus, there need to be
strict guidelines in place for this in order to avoid misunderstandings or
mistakes, such as a cut-off date for such requests to reach the payroll
department each month. This should be communicated to the employee at the time
of their request.
An employer is not allowed to take deductions from an employee's wages
unless they are statutory, which we will discuss in our next section, or
unless:
· The employee puts a request in writing for a deduction to be made, and
this is received by the employer's payroll department in time for it to be
processed in the next full payment submission to HMRC
· The employee's contract of employment states that a deduction can be
made, and this contract is signed by both the employee and employer at the time
of employment.
· If there is a mandatory payment which needs to be made to a public
authority, and this is communicated in writing to the employer
Aside from income tax, National
Insurance, student loan repayments and automatic enrolment workplace pension
payments, everything else taken from an employee's wages is classed as
voluntary and must be agreed to by the employee in writing.
8.3 Statutory Deductions?
Statutory deductions are those
required by law and comprise income tax contributions, National Insurance
contributions, student loan repayments, if applicable, and automatic enrolment
workplace pensions (please note: employees can choose to opt out of the
workplace pension).
Having studied this course so far you
should now be aware that there are rarely set rules that will apply to every
situation, and there are always anomalies that may arise in a payroll system.
In terms of statutory deductions, there are other non-standard
deductions which can be taken in this category:
- -A
deduction can be taken from an employee's wage if it is as a result of a
Court Order
- -If
the employee has done something which their contract says they are liable
for, and this contract is signed by both parties, e.g. a till suffering a
shortfall; in this case, the amount can be deducted from the employee's
wage
- -Repayment
of overpaid wages or expenses - however, this is to be discussed with the
employee before full repayment is taken; occasionally this can be agreed
to be taken over a set number of months if it is a large amount
- -The
employee has taken part in a strike or industrial action and did not work
during that time as a result - in that case, payment for those hours not
worked can be taken from the next wage
- -Accommodation
which is provided to the employee by the employer
- -Repayment
of a loan or advance
- -Purchasing
of shares in the business
It is worth noting that deductions
need to be communicated to the employee for anything other than the four
important statutory deductions (as stated in the first paragraph of this
section).
8.4 How Voluntary and Statutory
Deductions Affect an Employee's Net Pay
Whether deductions be voluntary or
mandatory - the more deductions there are, the less net pay an employee
receives.
Many employees choose to have
statutory deductions only taken from their wages, informing their employee's
payroll department should their circumstances change and they require a
voluntary deduction to be set up. No matter what deductions are taken from an
employee's wages, this needs to be documented clearly on their payslip.
8.5 How to Report Voluntary and
Statutory Deductions to HMRC
Thanks to technology, high-quality
payroll software performs the deduction calculations for you, so you simply
need to inform your software of what needs to be taken before you make your
submissions to HMRC.
Whenever you receive notification
from an employee that they wish for a voluntary deduction to be taken e.g. for
healthcare contributions, trade union membership, or for some other voluntary
reason, it is important to act on it immediately, to ensure the correct
deductions are taken at the right time. Again, if you outsource your payroll
then informing the provider of your employee's request immediately is very
important, otherwise, oversights can easily occur.
It
is a good idea to have a failsafe system in place in this situation, perhaps
with a phone call informing them but backed up by a written request, or through
a weekly catch-up with your outsourcing personnel.
Communication is everything in terms of getting your payroll system
right and in order to submit the correct figures to HMRC, whether this is
because of a change in personal circumstances for your employee, new staff,
retirees or voluntary deductions being communicated to you by your employee.
Copies of written requests for voluntary deductions should also be kept
on file, adhering to confidentiality and Data Protection laws. If an employee
wishes for a voluntary deduction to cease, they need to inform the employer in
writing, giving the employer sufficient notice in order to remove this
deduction from the payroll software.
Here are some important HMRC payroll terms to be aware of:
- Income
Tax Year: The
tax year always begins on April 6 and ends on April 5.
- Income
Tax Weeks: Income
tax weeks include 7 consecutive days starting from April 6. For example,
the first tax week is April 6 to April 12 (inclusive), the second tax week
would be April 13 to April 19 (inclusive) and so on.
- Income
Tax Months: Income
tax months start on the 6th of every month and end on the 5th. For
example, 6th April to 5th May, 6th May to 5th June, and so on.
- Pay
Period: Pay
periods for wages can be regular (weekly, bi-weekly or monthly) or
irregular.
- Payroll Record: Legal payroll records
contain updated details about income tax and NIC deductions for each
employee. As an employer, you must keep these records either on paper or
electronically. HMRC retains the right to query these at any time.
Every employer must file a full payment
submission online for each pay period. When you enter the voluntary deduction
into your payroll software and submit your full payment submission to HMRC at
the end of the week or month, HMRC will become aware of the deduction and note
it accordingly. Similarly, when you remove it due to your employee informing
you of their requirement change, HMRC are informed too.
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