PAYE Audits

What Is a PAYE Audit?

A PAYE audit is an employer compliance review carried out by HMRC to check that a business is correctly operating its payroll and meeting all of its obligations as an employer. HMRC conducts thousands of PAYE audits every year, targeting businesses of all sizes across every sector.

The purpose of a PAYE audit is to ensure that employers are deducting and paying the correct amounts of income tax, National Insurance contributions and other payroll-related obligations. If HMRC finds errors, the consequences can be significant – including backdated bills, penalties and ongoing increased scrutiny.

What Does HMRC Check During a PAYE Audit?

During a PAYE audit, HMRC will examine a wide range of employer obligations, including:

• PAYE deductions – Whether income tax is being correctly calculated and deducted from employees' pay using the right tax codes and in accordance with HMRC guidance
• National Insurance Contributions (NICs) – Employer and employee NIC calculations, including correct categorisation of employees and application of NI thresholds
• Benefits in kind – Company cars, private medical insurance, interest-free loans and other non-cash benefits provided to employees or directors. HMRC checks that these have been correctly reported on P11D forms and that the appropriate tax and NIC has been accounted for
• Employment status and IR35 – Whether workers engaged through intermediaries (such as personal service companies) should properly be treated as employees. IR35 compliance is an increasingly important area of focus for HMRC
• Student loan repayments – Correct deduction and payment of student loan repayments where employees have outstanding student loans
• Pension contributions – Compliance with automatic enrolment duties, correct calculation of pension contributions and timely payment to pension schemes
• Construction Industry Scheme (CIS) – For businesses in the construction sector, correct application of CIS deductions and filing requirements

Why Would HMRC Audit Your PAYE?

HMRC selects businesses for PAYE audits based on a combination of risk factors and random selection. Common triggers include:

• Discrepancies in submissions – Differences between your Real Time Information (RTI) submissions and your annual returns, or inconsistencies between PAYE, corporation tax and VAT figures
• Late or incorrect submissions – Persistent late filing of RTI submissions, frequent corrections or errors in payroll data sent to HMRC
• Whistleblower reports – Current or former employees, contractors or competitors may report concerns about payroll practices to HMRC
• Contractor-heavy workforce – Businesses that engage a high proportion of self-employed contractors or workers through personal service companies are more likely to be audited, particularly for IR35 compliance
• Industry-specific targeting – HMRC periodically focuses on specific sectors where non-compliance is considered more likely, such as hospitality, care, construction and professional services
• Random selection – A proportion of PAYE audits are selected purely at random to maintain compliance standards across all sectors

How Will You Know You Are Being Audited?

HMRC will write to you to notify you that a PAYE audit is being carried out. The letter will explain what the audit will cover, what records you need to prepare and when the auditor will visit your premises. You will typically be given at least 7 days' notice before the audit takes place.

Upon receiving the notification, you should immediately contact a specialist tax adviser. Do not attempt to handle the audit alone, as even well-intentioned responses can inadvertently create problems.

What Happens During a PAYE Audit?

A PAYE audit typically follows these steps:

1. Notification and preparation

   HMRC writes to you confirming the audit date and the records you need to make available. Your adviser will help you review your records in advance and identify any potential issues.

2. Opening meeting

   The HMRC auditor arrives at your premises and holds an initial meeting to explain the scope of the audit and ask general questions about your business, workforce and payroll processes.

3. Records examination

   The auditor reviews your payroll records, P11D forms, contracts of employment, expense claims, benefits documentation and any other relevant records. They may also check your accounting software and payroll systems.

4. Interviews and follow-up questions

   The auditor may interview directors, payroll staff or HR personnel to gain a deeper understanding of your payroll processes and employment practices. Always ensure your adviser is present during these discussions.

5. Findings and resolution

   After completing the review, HMRC will communicate their findings. If errors are identified, they will calculate any additional tax, NIC, interest and penalties owed. Your adviser will negotiate on your behalf to ensure the assessment is fair and penalties are minimised.

Common PAYE Mistakes Employers Make

Many PAYE audit issues arise from common, avoidable mistakes. The most frequent errors include:

• Misclassifying employees as self-employed – Treating workers as self-employed contractors when they should be on the payroll is one of the most common and costly errors HMRC identifies
• IR35 non-compliance – Failing to correctly assess the employment status of workers engaged through intermediaries, or not applying IR35 deductions where required
• Unreported benefits in kind – Not declaring company cars, private medical insurance, accommodation or other non-cash benefits on P11D forms
• Underpaying National Insurance – Using incorrect NI categories, failing to account for employer NIC on benefits or miscalculating thresholds
• Late Real Time Information (RTI) submissions – Not submitting Full Payment Submissions and Employer Payment Summaries on time, resulting in penalties and attracting HMRC attention
• Incorrect expense reimbursements – Reimbursing expenses that are not genuinely business-related, or failing to tax round-sum allowances

What If HMRC Finds Errors?

If HMRC identifies errors during a PAYE audit, the consequences can include:

• Backdated tax and NIC bills – HMRC can issue assessments for unpaid PAYE and NIC going back up to 6 years (or longer in cases of deliberate non-compliance), plus interest on late payments
• Penalties – Penalties for PAYE errors can range from 0% to 100% of the tax owed, depending on the nature of the error. Careless errors typically attract penalties of up to 30%, while deliberate errors can result in penalties of up to 100%
• Interest charges – Interest is charged on all underpaid tax and NIC from the date it should have been paid until it is settled
• Increased future scrutiny – A business that fails a PAYE audit is far more likely to be selected for future audits and compliance checks across all tax types

How to Disagree with HMRC's Findings

If you believe HMRC's assessment is incorrect or the penalties are disproportionate, you have several options for challenging the outcome:

• Internal review – You can request that a different HMRC officer reviews the decision. This is an independent review within HMRC and can sometimes result in a more favourable outcome
• Alternative Dispute Resolution (ADR) – HMRC offers an ADR service where an independent mediator helps both parties reach an agreement. ADR can be an effective way to resolve disputes without the cost and time of a tribunal
• Tax tribunal – If you cannot reach agreement through internal review or ADR, you can appeal to the First-tier Tribunal (Tax Chamber). Your adviser will prepare and present your case, and the tribunal will make a binding decision

How to Reduce the Risk of a PAYE Audit

While no business can completely eliminate the risk of being selected for a PAYE audit, there are practical steps you can take to reduce the likelihood and ensure you are well prepared if one does occur:

• Maintain accurate, complete and up-to-date payroll records at all times
• File all RTI submissions on time and check for errors before submitting
• Review the employment status of all workers regularly, particularly contractors and agency staff
• Ensure all benefits in kind are correctly reported on P11D forms each year
• Keep detailed records of all expenses reimbursed to employees and directors
• Stay up to date with changes in payroll legislation, particularly around IR35, auto-enrolment and NIC thresholds
• Consider a voluntary payroll health check by a specialist adviser to identify and correct issues before HMRC does

Prevention is always better than cure. If you are concerned about your payroll compliance, contact us for a confidential review before HMRC comes knocking.