PAYE (Pay As You Earn) is the system HM Revenue & Customs uses to collect Income Tax and National Insurance contributions directly from employees' wages or salaries before they receive them. For UK agency founders, PAYE is the mechanism you must operate whenever you have employees, including yourself if you take a salary from your agency. Under PAYE, you are legally responsible for deducting the correct tax and NI from each employee's pay, reporting those deductions to HMRC in real time, and paying the amounts over to HMRC monthly or quarterly.
When you hire your first employee or pay yourself a salary as a director, you must register as an employer with HMRC and set up a payroll system. Each time you run payroll, you calculate the employee's gross pay, then deduct Income Tax using the tax code HMRC provides (usually based on the personal allowance of £12,570 for 2025/26). You also deduct employee National Insurance at 8% on earnings between £242 and £967 per week, and 2% on anything above £967. As the employer, you must also pay employer National Insurance at 15% on earnings above £175 per week (the secondary threshold). These deductions are reported to HMRC through Real Time Information (RTI) submissions on or before each payday.
For agency founders, PAYE is particularly important because you cannot simply pay yourself dividends and ignore salary. A small salary (up to the NI threshold) can be tax-efficient because it counts as a deductible business expense and builds your state pension entitlement, while dividends take the bulk of your income. However, if you have other employees, you must operate PAYE correctly for them too, including freelancers or contractors who are deemed employees under IR35 rules. The penalties for failing to operate PAYE correctly can be severe, including fines and HMRC investigations.
When this matters for agency founders: PAYE is non-negotiable from the moment you have any employee, including yourself as a director taking a salary. Getting it wrong can lead to penalties, interest on unpaid tax, and reputational damage with HMRC. If you use an accountant or payroll software, ensure they handle RTI submissions and payment deadlines (usually 22nd of the following month for electronic payments). For most agency founders, a small salary of around £9,100 per year (to avoid employee NI) combined with dividends is the standard tax-efficient approach, but always check your specific circumstances with a qualified accountant.