Taking on your first employee can be daunting, but it is a necessary step for startups with the ambition to grow. Hiring employees allows you to focus on your strengths, rather than being a generalist managing all aspects of the business.
That said, employing staff comes with a range of legal, administrative, and compliance responsibilities related to their remuneration, rights, and overall well-being. It is essential to consider these obligations upfront to ensure compliance with employment laws and to understand the financial impact on your business.
This guide provides an overview of key considerations, including employment contracts, payroll setup, pensions, and employer liabilities. You’ll also find information on useful HR and payroll software, government incentives, and tax-efficient schemes like EMI share options.
By following these best practices, you can ensure compliance with UK employment law while streamlining your HR and payroll operations.
Setting up and managing payroll is a critical responsibility for employers, encompassing tasks such as calculating employees' net salaries and making necessary deductions for Income Tax, National Insurance contributions, pensions, and student loans. Employers are also obligated to pay their portion of National Insurance contributions.
To establish a compliant payroll system, employers should follow these steps:
Register as an Employer with HMRC: Before the first payday, register as an employer with HM Revenue and Customs (HMRC) to receive a Pay As You Earn (PAYE) reference number. This process can take up to 20 working days, so it's advisable to complete it well in advance, however you can't register more than two months before you start paying people.
Choose Payroll Software: Select HMRC recognised payroll software to record employee details, calculate pay and deductions, and report this information to HMRC. Popular options include Xero, QuickBooks, and Sage.
Maintain Accurate Records: Keep detailed records of employee payments, deductions, and other relevant information. This practice ensures compliance with legal requirements and facilitates smooth payroll operations.
Report to HMRC via RTI: Submit payroll information to HMRC on or before each payday using Real-Time Information (RTI) filings. This process ensures that HMRC has up-to-date records of all payments and deductions.
Given the complexity and potential risks associated with payroll management, some businesses opt to outsource this function to accountants or payroll service providers. For instance, Barnes & Scott handles payroll setup and administration for all their clients. While Xero's payroll feature is suitable for smaller companies, we use Brightpay Connect for its enhanced functionality.
All employees are entitled to an employment contract, which can be established verbally or in writing. However, employers are legally required to provide a written statement of employment particulars outlining the main terms and conditions of employment when the employee starts work.
Employment contracts should clearly define key terms of engagement, including job titles, descriptions, salaries, working hours, probation periods, and holiday entitlements. Full-time employees in the UK are entitled to a minimum of 28 days of paid annual leave, which can include bank holidays.
If there is uncertainty about whether an individual qualifies as an employee or a contractor, the government's Check Employment Status for Tax (CEST) tool (see here) can assist in determining the correct employment status for tax purposes.
It's important to note that under the off-payroll working rules (commonly known as IR35), the responsibility for determining a worker's employment status and ensuring the correct tax and National Insurance contributions lies with the hiring organisation, not the contractor.
Businesses operating in innovative or specialist sectors may include non-compete clauses to prevent employees from working for competitors for a set period after leaving the company. Original signed copies of employment contracts should be securely stored for internal records.
All UK employers are legally required to establish and manage a workplace pension scheme for their eligible employees. Under the Pensions Act 2008, employees aged between 22 and the State Pension age, earning above £10,000 annually, must be automatically enrolled into a qualifying pension scheme. Employees have the option to opt out after enrollment.
The total minimum contribution for auto-enrolled employees is 8% of qualifying earnings, with at least 3% contributed by the employer and the remaining 5% by the employee.
Employers must select a pension provider to administer the workplace pension scheme. The National Employment Savings Trust (NEST), established by the government, is a popular and accessible option for employers seeking a straightforward solution.
For comprehensive guidance on selecting a pension scheme and staying updated on contribution rates, employers should consult The Pensions Regulator's website.
Employers are legally required to obtain employers' liability insurance to protect against compensation claims arising from employees becoming injured or ill due to work-related activities. This insurance must cover at least £5 million and be obtained from an authorised insurer.
Most businesses must have this insurance, even if their workforce consists of contractors or casual workers. However, there are specific exemptions, such as:
Failure to comply can result in fines of £2,500 for each day without cover. Additionally, employers can be fined £1,000 if they do not display the employers' liability insurance certificate or refuse to make it available to inspectors when requested.
If you already have business insurance, you can often add employers' liability insurance at a relatively low cost. Contact your existing insurance provider first to explore this option.
Implementing cloud-based HR solutions like CharlieHR, BrightHR, HiBob and BambooHR can significantly streamline HR processes such as storing personal data, handling holiday requests, conducting performance reviews, and processing payroll-related data. These platforms offer affordable subscription models, with prices starting from just a few pounds per month per employee, and many providers also offer free trials.
At Barnes & Scott, we use CharlieHR and highly recommend it as an efficient and cost-effective tool.
When utilising such tools, it's essential to ensure compliance with data protection regulations, such as the General Data Protection Regulation (GDPR). This includes implementing strong data security measures like encryption, access controls, and regular software updates. Additionally, conducting regular training programs for all employees on data protection best practices is crucial to maintaining a secure environment.
By integrating these HR solutions and adhering to data protection guidelines, businesses can enhance operational efficiency while safeguarding sensitive employee information.
Businesses can claim up to £5,000 per year against employer Class 1 National Insurance contributions (NICs) through HMRC's Employment Allowance, designed to reduce their annual National Insurance liability.
Most businesses and charities qualify for this allowance. However, eligibility criteria can be complex, and misunderstandings may lead to significant tax liabilities. Therefore, it's advisable to consult with a professional accountant to ensure compliance with HMRC's requirements.
To claim the Employment Allowance, you can use your payroll software or have your accountant submit an Employer Payment Summary (EPS) to HMRC. If you have been employing staff for several years but have not claimed the allowance, you may be able to claim it retrospectively, subject to certain conditions.
Before hiring new employees, companies should assess the full cost of employment beyond just salaries. Employers must budget for additional costs such as National Insurance contributions and pension contributions.
Example calculation (based on 2025/26 rates):
| Expense | Amount |
|---|---|
| Full-time salary | £40,000 |
| Employer's Class 1 NICs (15% above £5,000) | £ 5,250 |
| Employment Allowance deduction | £- 5,250 |
| Employer’s pension contribution (3%) | £ 1,200 |
| Total annual cost | £41,200 |
Notes:
The Employment Allowance has been increased to £10,500 per year starting from April 2025, allowing eligible employers to reduce their annual National Insurance liability by this amount.
For additional employees, costs will be higher as the Employment Allowance is limited to £10,500 total per year.
Enterprise Management Incentive (EMI) share option schemes are a tax-efficient method for high-growth companies to attract and retain top talent without offering high salaries. These schemes allow employees to acquire shares in their employer company at a future date for a price set at the time the options are granted.
Tax Advantages:
At Grant: Employees do not pay Income Tax or National Insurance Contributions (NICs) when EMI options are granted.
At Exercise: If the exercise price is at or above the market value of the shares at the time the options were granted, no Income Tax or NICs are due upon exercising the options.
At Sale: Upon selling the shares, any gain is subject to Capital Gains Tax (CGT). Gains from EMI shares may qualify for Business Asset Disposal Relief (formerly Entrepreneurs' Relief), reducing the CGT rate to 14%.
Note: Tax treatments can vary based on individual circumstances and specific scheme terms. It's advisable to consult HMRC guidelines or a tax professional for detailed information.
If you would like some guidance with taking on your first employee or any aspect of running Payroll, then please get in touch through our website.
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