Taking on your first employee is one of the most exciting moments in a small business owner's journey. It's also one of the most administratively significant. Before your new hire's first payday arrives, you need to have PAYE — Pay As You Earn — set up correctly. Get it wrong and you risk penalties from HMRC, underpaid tax, and a very awkward conversation with the person you've just welcomed on board. Get it right, and it becomes a straightforward part of your monthly routine. Here's everything you need to know.
What Is PAYE and Why Does It Apply to You?
PAYE is HMRC's system for collecting Income Tax and National Insurance contributions (NICs) directly from employees' wages before they receive their pay. As an employer, you become the collector. You deduct the correct amounts, pay them to HMRC, and report everything in real time using a system called Real Time Information (RTI).
You must register for PAYE if you're paying an employee at or above the Lower Earnings Limit — currently £123 per week for the 2024/25 tax year — or if you're providing any taxable benefits such as a company car or private healthcare. Even if you only have one member of staff working part-time, the obligation applies.
It's worth being clear: PAYE isn't optional. Operating outside it — paying staff cash in hand without deducting tax — exposes you to significant back-tax liability plus interest and penalties. HMRC has considerable powers to investigate and recover unpaid amounts, sometimes going back years.
Step 1: Register as an Employer with HMRC
You must register as an employer before your new employee's first payday — ideally at least two weeks in advance, because HMRC can take up to five working days to issue your PAYE reference numbers, and you'll need them to submit payroll data.
The registration process is done online via the Government Gateway. You'll receive two reference numbers:
- Employer PAYE reference — a number formatted like 123/AB456, used on all payroll submissions and correspondence with HMRC.
- Accounts Office reference — a 13-character number used when making PAYE payments to HMRC.
Keep both safe. You'll use them regularly. Once registered, you also need to consider whether you require Employers' Liability Insurance — a legal requirement the moment you take on staff, with a minimum cover of £5 million. The Health and Safety Executive (HSE) can issue fines of up to £2,500 per day if you don't have it.
Step 2: Collect the Right Information from Your Employee
Before you can run your first payroll, you need specific details from your new hire. Ask them to provide:
- Their full name, date of birth, address, and National Insurance number
- Their P45 from their previous employer — this tells you what tax code to use and how much they've earned in the current tax year
- A completed starter checklist (formerly P46) if they don't have a P45 — this determines their correct tax code via a series of declarations
The starter checklist is particularly important. If an employee ticks Statement A (this is their only job and they have no other income), they'll typically receive the standard tax code of 1257L for 2024/25, meaning they can earn £12,570 before paying any Income Tax. If they tick Statement B or C, a different code applies — and using the wrong one from day one creates headaches for everyone later.
Step 3: Set Up Payroll and Submit Your First FPS
Once you have your employer references and employee details, you need payroll software that can submit RTI data directly to HMRC. Every time you pay an employee, you must submit a Full Payment Submission (FPS) on or before payday — not after. Late FPS submissions attract automatic penalties starting at £100 per month for one to nine employees.
Your payroll software should calculate:
- Gross pay for the period (salary, overtime, commission, etc.)
- Income Tax due under the employee's tax code
- Employee National Insurance contributions (12% on earnings between £242 and £967 per week; 2% above that for 2024/25)
- Employer National Insurance contributions (13.8% on earnings above £175 per week — though the Employment Allowance can offset up to £5,000 of this per year if you're eligible)
- Any pension contributions under auto-enrolment (more on that below)
If you're looking for software that handles all of this without needing to piece together separate tools, BizHub365 includes a full RTI-compliant payroll module. It submits FPS and EPS filings directly to HMRC via the Government Gateway API — no bridging software, no manual uploads — and generates payslips, P60s, and P45s automatically.
Step 4: Understand Auto-Enrolment Pension Obligations
Auto-enrolment is often the part new employers forget — until The Pensions Regulator (TPR) sends a compliance notice. If your employee is aged between 22 and State Pension age, earns more than £10,000 per year, and works in the UK, you must automatically enrol them into a qualifying workplace pension scheme.
The minimum contributions for 2024/25 are:
- 3% from the employer (on qualifying earnings)
- 5% from the employee (including tax relief)
You need to choose a pension provider — NEST is the government-backed option and accepts all employers — and declare your compliance to TPR within five months of your duties start date. Employees can opt out within one month of being enrolled, but you must enrol them first. You also need to re-enrol eligible staff every three years, even if they previously opted out.
Don't underestimate TPR's willingness to act. Fixed penalty notices start at £400, and escalating penalties for continued non-compliance can reach £10,000 per day for larger employers.
Step 5: Pay HMRC and Keep Accurate Records
Each month (or quarter, if your PAYE liability is under £1,500 per month), you must pay HMRC the combined Income Tax and NICs deducted from your employee, plus your own employer NIC contribution. Payment is due by the 19th of the following month if paying by post, or the 22nd if paying electronically. Missing these deadlines triggers interest charges.
You're also legally required to keep payroll records for at least three years after the end of the tax year they relate to. This includes payslips, employee details, details of payments and deductions, and copies of any statutory payments made — for example, Statutory Sick Pay (SSP) or Statutory Maternity Pay (SMP).
If you ever have no employees to pay in a given month but are still registered as an employer, you must submit an Employer Payment Summary (EPS) to tell HMRC that no FPS is due. Failing to do so results in HMRC estimating what you owe — often incorrectly — and issuing demands accordingly.
Bringing It All Together
Setting up PAYE for your first employee involves several moving parts: registering with HMRC, collecting the right starter information, choosing compliant payroll software, meeting your auto-enrolment duties, and making payments on time every month. It sounds like a lot — and in the early days, it can feel that way. But once the systems are in place, payroll becomes a reliable rhythm rather than a recurring scramble.
The key is to start early, use software that talks directly to HMRC, and never miss a deadline. If you're managing payroll alongside invoicing, VAT returns, and everything else that comes with running a small business, having everything in one place makes a genuine difference. Whether you use BizHub365 or another compliant platform, the goal is the same: pay your people accurately, report to HMRC on time, and give yourself one less thing to worry about.