As an employer, you have a number of legal obligations to do with paying employees. If you don't follow the proper procedures - including paying your male and female employees equally and fairly - you could have penalties to pay.

This guide aims to help you understand your obligations that include the need to supply an itemised pay statement and to comply with National Minimum Wage law. You must also make statutory payments including maternity, paternity, adoption, sick and guarantee pay. 

It also describes what deductions from workers' wages are unlawful.

Issuing pay statements

As an employer you are legally obliged to give each employee a written itemised pay statement, usually known as a payslip or wage slip. You must issue it at, or before, the time you pay your employee.

This right does not apply to:

• people you pay who are non-employees, eg freelancers and contractors
• certain other groups, including police and some people who work at sea

The itemised pay statement must show:

• the gross amount of the wages or salary before deductions
• the amounts of - and reasons for - any fixed deductions that you make every pay period and any variable deductions that are not the same every pay period
• the net amount of wages or salary payable after deductions
• a breakdown of each part-payment - such as part by cheque, part in cash

The pay statement does not have to include the amount and purpose of every separate fixed deduction every time, but if you don't issue a payslip that does this, you must give the employee a standing statement of fixed deductions at least every 12 months.

Variations in fixed deductions

If there is any change to an employee's fixed deductions, you must give them either:

• notification in writing of the details of the change
• an amended standing statement of fixed deductions, which is then valid for up to 12 months

Penalties

If you don't give your employees an itemised pay statement, or include all the required details, they could complain to an employment tribunal. If the tribunal finds that you did not give proper notice of any deductions, they can order you to repay the employee the unnotified deductions you made in the 13 weeks before the employee filed the complaint, even if you were entitled to make them.

Employees must make their complaint whilst employed by you or within three months of leaving.

Statutory Maternity, Paternity and Adoption Pay

Employees who become parents, including through adoption, are entitled to a number of payments, including Statutory Maternity, Paternity and Adoption Pay.

To qualify the employee must:

• have worked continuously for you for at least 26 weeks by the 15th week before the expected week of childbirth - or by the date they are notified they have been matched with a child for adoption
• earn more than the lower earnings limit for National Insurance contributions (NICs) - £82 a week for the 2005/06 tax year or £84 a week for the 2006/07 tax year

For further information you can call the HM Revenue & Customs Employer Helpline on Tel 08457 143 143.

Statutory Maternity Pay (SMP)

SMP is payable at a rate of 90 per cent of average earnings for the first six weeks. The remaining 20 weeks are paid at the standard rate set by the government, which is the lower of £106 per week for the 2005/06 tax year or 90 per cent of the woman's average weekly earnings. The payments are subject to normal deductions. From April 2006, SMP rises to £108.85 per week.

You must pay 26 weeks' SMP even if the employee leaves work after the start of the 15th week before the expected week of childbirth. Paid maternity leave will be extended to 39 weeks from April 2007.

Statutory Paternity Pay (SPP)

Working fathers are entitled to up to two weeks' paternity leave within 56 days of the birth, if they:

• have a responsibility for the child's upbringing
• are the child's biological father, or the mother's husband or partner
• have worked continuously for you for at least 26 weeks by the 15th week before the expected week of childbirth - or by the date they are notified they have been matched with a child for adoption
• earn more than the lower earnings limit - £82 a week for the 2005/06 tax year or £84 for the 2006/07 tax year
• have continued working for you until the birth of the child

Paternity leave must be taken in periods of either one week or two continuous weeks. The rate of paternity pay is the same as the standard rate of maternity pay. From April 2006, SPP rises to £108.85 per week.

Statutory Adoption Pay (SAP)

Employees who adopt a child are entitled to adoption leave for up to 52 weeks - SAP is paid for a maximum of 26 weeks at a flat rate of £106 for the 2005/06 tax year or 90 per cent of the adopter's average weekly earnings if that is less than the flat rate. From April 2006, SAP rises to £108.85 per week.

Employees who adopt individually are entitled to adoption leave and pay. Where a couple adopt together, one member of the couple is entitled to adoption leave and pay. The couple can decide which partner will take adoption leave. Paternity leave and pay may be available to the partner of an individual who adopts or to the other person in a couple who are adopting together.

You should keep detailed records of payments and leave periods.

In all cases of Statutory Maternity, Paternity and Adoption pay, you can claim most or all of this money back from the income tax and NICs paid to HM Revenue & Customs (HMRC), who can also give advance funding if needed.

See our guide on maternity, paternity & adoption - an overview.

Statutory Sick Pay

Under certain conditions, you may have to pay an employee Statutory Sick Pay (SSP). This is the minimum level of payment you must make to an employee who is off work through illness - their contract may entitle them to more than this.

Some people are not entitled to SSP, including:

• employees who are sick for less than four days in a row
• people you pay who are non-employees, eg freelancers and contractors
• employees who are under 16 or over 65 on the first day of sickness
• employees who earn less than the lower earnings limit for National Insurance contributions (NICs) - £82 a week for the 2005/06 tax year or £84 a week for the 2006/07 tax year
• employees who have recently claimed state incapacity benefit or severe disablement allowance

You must pay SSP to employees who cannot work for four or more days in a row, including weekends and holidays, because of illness or disablement.

The maximum time for which an employee may be entitled to SSP is generally 28 weeks for any one period of sickness.

The current SSP rate - for tax year 2005/06 - is £68.20 a week and pro rata for fractions of the working week. You must deduct income tax and NICs where appropriate. This rate will rise to £70.05 for tax year 2006/07.

You may be able to recover some SSP from the income tax and NICs that you pay to HM Revenue & Customs (HMRC). If your total SSP payments are more than 13 per cent of the total gross Class 1 National Insurance liability for your whole company in the same tax month, you can get the difference back. The amount you may recover is the amount by which the SSP you have paid exceeds 13 per cent of your National Insurance liability.

You must keep records, for at least three years, of any SSP you pay and of the dates of any periods of sickness lasting at least four days in a row.

Find out about SSP at the Department for Work and Pensions (DWP) website.

You can also find out about SSP at the HMRC website.

Guarantee pay

Employees may have the right to fallback pay, or guarantee pay, if you don't need them to do the work of the kind you employed them for, eg because there is a downturn of work in your business or as a result of occurrences such as power cuts or floods.

If you don't provide the employee with work throughout a complete day, during which they would normally be required to work, they are entitled to a statutory guarantee payment. The maximum payment they can get is five days in any period of three months.

The amount of guarantee payment for any day is calculated by multiplying the number of normal working hours for the day in question by the guaranteed hourly rate, subject to an upper limit for any one day, which is currently £18.90 per day (from 1 February 2006).

The right to guarantee pay applies only to employees, not other workers. See our guide on employment status.

You do not have to pay guarantee pay if:

• the employee's contract is for three months or less
• they are not available to work
• you offer them suitable alternative work
• they are on strike or cannot work because of a strike
• they have been continuously employed for less than one month
• their employment contract does not require them to accept work that is offered to them
• you have a collective agreement covering guarantee pay that has been approved by the appropriate government minister

If you don't give employees the guarantee pay to which they are entitled, they have three months to complain to an employment tribunal.

Complying with the National Minimum Wage

You must ensure you pay your workers at least the National Minimum Wage (NMW). This applies to most workers who are:

• aged 18 and over including homeworkers, agency workers, part-time workers, casual workers, piece workers, workers who are paid by commission and workers on short-term contracts
• since 1 October 2004, young workers aged 16 to 17 who are above the age of compulsory schooling
• apprentices aged 19 to 25 after 12 months' apprenticeship

There is a separate minimum wage for agricultural workers. You can read about the minimum wage for agricultural workers on the Department for Environment Food and Rural Affairs (Defra) website.

Among those not entitled to the NMW are:

• apprentices under the age of 19 and those between 19 and 25 in the first year of their apprenticeship
• share fishermen
• genuine voluntary workers
• au pairs living as part of the family
• family members living at home and helping to run a family business
• UK university or college students on placement with an employer as part of their course, ie a sandwich course that is no longer than one year
• genuinely self-employed

Rates and calculation of the National Minimum Wage

As of 1 October 2005, the three rates of the National Minimum Wage (NMW) are:

• The adult rate of £5.05 per hour for workers aged 22 and over.
• The development rate of £4.25 per hour for workers aged 18 to 21. The development rate for those aged 22 or over who receive accredited training for six months after they start work with a new employer also stands at £4.25 an hour as of 1 October 2005.
• A third rate of £3 per hour for workers aged 16 to 17 and who are above the age of compulsory schooling.

Calculating the NMW

How the NMW is calculated depends on whether the work is:

• time work - a set number of hours or period of time
• salaried-hours work - a set number of hours each year, paid by annual salary
• output work - payment is according to the number of things produced or tasks performed
• unmeasured work - specific tasks but no set hours

On 1 October 2004 the government introduced changes on how the minimum wage applies to output workers. They are those paid by the piece of work produced or task performed, and include homeworkers. Employers either had to pay their output workers the minimum wage for every hour they work, or pay a fair piece rate that allowed an average worker to earn the minimum wage.

From 6 April 2005, the way in which fair piece rates are calculated changed. If you pay your output workers a fair piece rate allowing the average worker to get the minimum wage, that rate must be multiplied by 1.2. This is aimed at making sure that output workers who are slightly slower than average will receive the NMW. Download guidance about fair piece rates from the Department of Trade and Industry (DTI) website (PDF).

Read the guide on the NMW for employers on the DTI website.

If you underpay your workers, they could complain to HM Revenue & Customs, or could take the case to an employment tribunal or civil court.

Paying workers holiday pay

As an employer you are required to allow each worker to take paid annual leave equal to four weeks in each year. This holiday should be taken by the worker and cannot be substituted by pay in lieu even if the worker agrees - except for accrued untaken leave at the time the employment ends.

The law says four weeks but this is translated by most employers into the equivalent number of days, eg 20 days for those who work five days a week or 24 for those who work six days a week. This allows workers to take odd days rather than having to take whole weeks as holiday.

This entitlement, which should be clearly set out in the worker's contract, does not have to be in addition to bank holidays although these are usually allowed in addition to other holiday and are also generally given as paid leave. This depends mostly on the commercial sector you are in, eg almost all offices close on bank holidays but most large shops are open.

Rates of pay

The rate of holiday pay is generally the normal rate for the worker. So for salaried workers, their annual salary is divided into 12 equal payments and when they take holiday it has no effect on their pay slip.

Only where your workers have varying pay rates, such as piece work, is there the need to work out a special payment. In those cases, the holiday pay will be equal to the average rate over the 12 weeks before the holiday.

This only applies to the statutory holiday periods. So if you offer extra leave over and above the four weeks (including bank holidays), then the rate of pay for these can be whatever is agreed with your employees.

In the real world, holiday pay, like normal pay, is dictated by market rates. If you offer less annual leave and lower rates of pay than your competitors, you are unlikely to get the best workers.

Making deductions

Ensure that any deductions you make from a worker's pay are allowed for in their contract. Otherwise they may claim for breach of contract.

Deductions are unlawful unless:

• They are legally authorised, eg PAYE income tax and National Insurance contributions.
• It is allowed by the worker's contract - they have a copy of the relevant term or a written explanation before you make the deduction.
• Workers have agreed in writing before you deduct pay for other reasons, eg as loan repayments or pension contributions.

For information, see our guides on how to manage student loans, payroll and other deductions and operate a year-round PAYE system.

These conditions do not always have to be met, eg if you make deductions to refund an overpayment of wages, or the employee is on strike or if the deduction is to satisfy a court order, eg to recover debts. However, the worker must have agreed in advance, in writing.

If your workers do retail work, you may make deductions from wages to recover cash shortages or stock deficiencies only if, in addition to the above, you:

• inform the worker, in writing, of the total shortfall you are recovering before the deduction is made 
• issue a written demand on a pay day for the repayment
• make the deduction - or the first in a series - no sooner than their first pay day after telling them of the shortfall, or, if you tell them on a pay day, not before that day
• do not deduct more than one tenth of the worker's gross pay on any given pay day - any remaining shortfall can be recovered on future pay days
• make the first deduction within 12 months of discovering the shortage

What counts as pay

The following count as pay:

• fees
• bonuses
• holiday pay
• statutory payments, ie Statutory Sick Pay, Maternity, Paternity and Adoption Pay

See the pages in this guide on Statutory Maternity, Paternity and Adoption Pay and Statutory Sick Pay.

Pay does not include:

• loans to the employee
• refunds for expenses
• pensions
• redundancy payments
• tips paid directly to the employee 

Calculating final pay

When an employee leaves, you must give them:

• any outstanding pay including overtime
• any outstanding holiday pay
• bonus payments, if earned
• Statutory Sick Pay, if they are entitled to it
• Statutory Maternity Pay, if they are entitled to it
• pay instead of notice if you are not allowing the employee to work their notice period

Some businesses also give the employee:

• a pension refund, depending on the rules of the scheme
• a golden handshake or extra payment as optional compensation for loss of their job
• contractual redundancy pay if you have made an employee redundant

What you should deduct from an employee's final pay

You must deduct the following items from what you owe the employee:

• income tax (PAYE)
• relevant National Insurance contributions

Some businesses also deduct:

• money given for season ticket loans
• any other outstanding loans
• amounts to be paid under any car leasing agreements

Redundancy payments

If you make an employee redundant, you should give them statutory redundancy pay in addition to their contractual pay if they have been working for you continuously for at least two years since turning 18. For more information, see our guide on making an employee redundant or use our interactive tool to get a checklist of how to handle potential redundancies.