Advantages & Disadvantages of Pay As You Earn (PAYE) System

Under Pay As You Earn (PAYE) System employers are responsible to deduct both income tax & NIC from employees’ wages before they receive their pay based on the PAYE tax tables issued by HMRC. This system was first introduced in 1944. HMRC provides an unique tax code to every employee depending upon the earning of the employee. Employers use this tax code to calculate the tax an employee owes. In this system employer need to report PAYE deduction to the respective tax authority before each payday. Employee can verify the PAYE details with employer at any time reviewing his or her pay slip or past year P60.

This system ensures that every employee meets their tax obligations regularly. Therefore employee needs not to be worried about the payment of a lump sum amount at the end of a tax year. This system brings a financial stability for both employee and the government. But it has some disadvantages also.

Here are some advantages and disadvantages of PAYE System-

Advantages:

Convenience for Employees: Employees don’t have to worry about setting aside money for taxes, as deductions are made automatically. It simplifies the tax system for employee. It allows tax credit to employee which in turn reduce employee’s tax liabilities.

Regular Tax Collection: PAYE system helps Government receive tax revenue consistently throughout the year.
Simplified Process: PAYE is the most simplest way to submit tax return in UK. It reduces administrative burden on employees too.

Real-Time Tax Adjustment: PAYE allows for adjustments in tax deductions based on changes in salary or tax code, keeping with current tax obligations.

Timely Payments: Employees pay tax on their earnings as they receive them.

Tax Avoidance: The system prevents tax avoidance as every employee pays their tax on a monthly basis. They never get enough scope to use any legal methods by which they can minimize their tax amount.

National Insurance Contributions: PAYE also integrates National Insurance Contributions and paid by the employer. As it’s paid by the employer so employee automatically qualify for certain benefits and state pension. National Insurance is a mandatory form of social security in the UK.

Disadvantages:

Cash Flow Issues for Employees: As a significant portion of employee’s paycheck is getting deducted so many employees can face cash flow issues. It adversely affect their monthly budgeting.

Burden for Employers: Managing PAYE system for every employee creates an extra burden on employers. Managing deductions can be complex for employers, requiring accurate calculations and timely payments to tax authorities. Employers need to keep them updated with the tax regulations. They may have to an extra expenses to deploy a dedicated resource for mainlining the entire system.

Limited Flexibility: Employees have little control over their withholding amounts, which can result in over-payment or underpayment of taxes throughout the year.

Compliance Risks: Errors in payroll processing can lead to penalties for both employers and employees if taxes are miscalculated or improperly filed.

Disincentives for Higher Earnings: Some employees may feel discouraged from earning more if they perceive that higher earnings will lead to a significant tax burden.

Conclusion:

Overall the PAYE system enhances the tax efficiency. Besides ensuring the tax and social insurance collection it reduces employee’s tax burden. Therefore it can be considered as one of the best tax return system for professionals in UK.