How to Set Up Payroll for a Business in India
Setting up payroll correctly is critical for Indian employers — non-compliance with EPF, ESI, Professional Tax, and TDS obligations attracts penalties, interest, and prosecution. A compliant payroll system ensures employees receive correct pay while the business meets all statutory obligations on time. Getting the salary structure, registrations, and monthly filing calendar right at the outset avoids costly rework once headcount grows, since retroactively fixing CTC breakups or missed PF enrolments can trigger back-dated contributions and interest. Most first-time employers underestimate how many separate portals and due dates are involved — EPFO, ESIC, the state Professional Tax authority, and the TRACES/TDS system each run on their own cycle. This guide walks through the full setup sequence a CA firm would follow when onboarding a new employer client, from CTC design to the first statutory challan.
Before you start
- PAN and TAN of the employer
- EPF establishment registration (mandatory for ≥20 employees)
- ESI registration (mandatory for employees earning ≤₹21,000/month in establishments with ≥10 employees, threshold varies by state)
- Professional Tax registration in the relevant state (not applicable in every state — some states, like Haryana, do not levy PT)
- Salary structure for each employee (CTC breakup: basic, HRA, allowances, PF, ESI)
- Shops & Establishment / Factory registration as applicable to the business location
- Bank account enabled for bulk salary disbursement or NACH/salary upload
- Payroll software or a payroll register template to track monthly computations and statutory ledgers
Step-by-step
Design the Salary Structure (CTC Breakup)
Structure the Cost to Company (CTC) with components that balance take-home pay and tax efficiency: Basic + DA, HRA, LTA, Special Allowance, and employer PF/ESI contributions. Under the Code on Wages, 2019 (in force nationally since 21 November 2025), Basic + DA (and any retaining allowance) must now equal at least 50% of total remuneration for wage-earning employees at establishments covered by EPF — this is a statutory floor, not just a design preference, and pushes most CTC structures above the older 30–40% Basic norm. Central rules under the Code were still being finalized into 2026 with state-by-state rollout, so confirm your state's notified rules before finalizing offer letters, and review the structure against the current-year income tax slabs.
- Do not treat Basic below 50% of remuneration as safe by default — verify against the Code on Wages wage definition and your state's implementation status, since raising Basic to comply also raises the PF contribution base for both employer and employee.
- Decide upfront whether the company will follow the old or new tax regime as default for TDS computation. Employees elect this under Section 115BAC of the Income-tax Act, 1961 for FY2025-26; from FY2026-27 (payroll from April 2026 onward) the equivalent provision is Section 202 of the Income-tax Act, 2025 — confirm which is current for the payroll period in question.
Register for All Statutory Obligations
Ensure the company has: an EPF establishment code from EPFO, an ESI sub-code from ESIC, Professional Tax registration from the state commercial tax authority (where applicable), and a TAN for TDS deduction. These registrations must be in place before the first payroll run, and most can be applied for online through the Unified Shram Suvidha Portal or the respective state portal. Note that since 21 November 2025 the underlying statutory basis for EPF and ESI sits within the Code on Social Security, 2020 (which consolidates the former EPF & MP Act, 1952 and ESI Act, 1948) — the EPFO and ESIC portals and registration mechanics are unchanged, but cite the Code rather than the standalone Acts going forward.
EPF registration becomes mandatory once headcount touches 20; many employers register voluntarily earlier to avoid a compliance scramble during a hiring spurt. ESI thresholds and applicability can vary slightly by state and industry — confirm the current headcount and wage threshold with a compliance professional before assuming exemption.
Collect Employee KYC and Tax Declarations
Collect Form 12BB from each employee at the start of the financial year — this declares their investment proofs (Section 80C, 80D, HRA, LTA, home loan interest) that reduce taxable salary. Collect PAN, Aadhaar, bank account details, and UAN (Universal Account Number, for employees who already have a prior PF account) for payroll records.
Also record the employee's chosen tax regime for the year, since the default regime and the opt-in process affect how much TDS is withheld each month. Missing or incomplete KYC is one of the most common reasons payroll runs get delayed in the first cycle.
Configure the Payroll Calendar and Cut-off Dates
Fix a monthly cut-off date for attendance, leave, and reimbursement data submission — typically a few days before month-end — so payroll processing and statutory computation can be completed in time for the pay date. Align this calendar with the statutory due dates in step 6 so there is no last-minute crunch.
Communicate the calendar to managers and HR so attendance regularization and leave approvals happen before the cut-off, not after.
Run Monthly Payroll Computation
Each month, compute: gross salary, statutory deductions (employee PF: 12% of basic+DA, ESI: 0.75% of gross for employees earning ≤₹21,000/month), Professional Tax per the applicable state slab, and TDS based on the employee's declared investments and chosen regime. The employer also contributes separately: PF at 12% of basic+DA (split across EPF and EPS components) and ESI at 3.25% of gross wages.
- Recompute TDS whenever an employee's CTC, regime choice, or investment declaration changes mid-year.
- Reconcile Loss of Pay (LOP) days against attendance before finalizing gross salary.
Disburse Salary and Issue Payslips
Transfer net salary to employees' bank accounts by the agreed pay date — most Indian employers pay by the last working day or within the first week of the following month. Issue a detailed payslip showing gross salary, all deductions, and net take-home.
Payslips are required under the Payment of Wages Act framework and are essential documentation for employees' loan applications, visa processing, and rental agreements, so timeliness and accuracy matter beyond pure compliance.
File Monthly Statutory Challans
By the 15th of each month, deposit PF contributions via the ECR (Electronic Challan-cum-Return) on the EPFO portal, ESI contributions on the ESIC portal, and the Professional Tax challan on the relevant state portal. TDS on salary must be deposited by the 7th of the following month, with a quarterly TDS return filed by the prescribed due date each quarter. For FY2025-26 payroll, this is TDS under Section 192 of the Income-tax Act, 1961, reported on Form 24Q; the new Income-tax Act, 2025 (effective 1 April 2026) renumbers this to Section 392 and replaces Form 24Q with Form 138 for TDS deducted from FY2026-27 onward — confirm which regime applies to the payroll month you are filing for.
Missed or late filings on any of these portals trigger interest and, for PF specifically, additional damages — confirm current due dates each filing cycle, as portal timelines and form numbers are being actively revised through 2026 as the new Labour Codes and Income-tax Act, 2025 roll out.
Issue Annual Tax Certificates
After the financial year closes, generate and issue the annual salary TDS certificate to every employee from whose salary tax was deducted, summarizing gross salary, exemptions, deductions, and tax paid. For FY2025-26 this is Form 16 (due by 15 June 2026); under the Income-tax Act, 2025, the equivalent certificate for FY2026-27 onward is Form 130. This must reconcile with the TDS reported in the quarterly salary TDS return (Form 24Q for FY2025-26; Form 138 from FY2026-27) and the amounts reflected in each employee's Form 26AS/AIS.
Reconcile PF and ESI Annual Returns
File the annual PF return and reconcile ESI contributions for the year, cross-checking that monthly ECR filings match the actual disbursed wages. Discrepancies flagged during EPFO or ESIC inspections are far easier to resolve when monthly records are complete and consistent.
Set Up a Compliance Tracker or Engage a Payroll Processor
Maintain a running tracker of due dates (PF, ESI, PT, TDS, annual returns) with the person responsible for each filing, or engage a payroll processing service once headcount or filing complexity grows beyond what an in-house team can reliably manage.
A structured tracker — even a simple spreadsheet with reminders — meaningfully reduces the risk of a missed deadline as the business scales across states or business units.
Common mistakes to avoid
- Excluding allowances from ESI contribution — all earnings (except HRA, certain overtime, and pure reimbursements) generally form part of gross wages for ESI calculation.
- Not collecting Form 12BB before paying salary — without investment declarations, TDS must be deducted at slab rate without 80C/HRA benefit, leading to excess deduction disputes later.
- Missing PF ECR deadlines — late PF deposits attract interest and possible damages under the Code on Social Security, 2020 (which consolidates the former EPF & MP Act provisions, in force since 21 November 2025), and repeated delays invite EPFO scrutiny.
- Issuing salary in cash for larger amounts — bank transfer is required above the threshold prescribed under wage-payment provisions now consolidated in the Code on Wages, 2019, in most states; confirm the current limit.
- Assuming Professional Tax applies uniformly — PT slabs, exemptions, and even applicability differ by state, and some states don't levy it at all.
- Not updating TDS computation when an employee changes tax regime or submits late investment proofs, resulting in a large one-time deduction adjustment near financial year-end.
- Treating contractor or consultant payments as salary for payroll purposes — misclassification affects TDS section (192 vs 194J/194C) and can trigger reclassification demands.
- Delaying ESI/PF registration until after crossing the headcount threshold, rather than tracking headcount monthly and registering proactively.
- Keeping legacy CTC structures with Basic under 50% of remuneration without checking the Code on Wages, 2019 wage floor and your state's notified implementation status.
Frequently asked questions
Is EPF mandatory even if employees' salaries are above ₹15,000?
Employees earning above ₹15,000 basic+DA are treated as exempt from mandatory EPF enrolment as new members. However, existing PF members must continue contributions regardless of salary growth, and the employer must keep contributing for them. New high-earning joiners can typically opt out with proper documentation, though this is often assessed case by case.
What is the difference between CTC and gross salary?
CTC (Cost to Company) includes all cash components plus employer-side statutory contributions (PF, ESI, gratuity provisioning) and any other employer costs. Gross salary is the employee's total cash pay before statutory deductions. Take-home (net salary) is gross minus employee-side deductions — PF, ESI, Professional Tax, and TDS.
When must a company switch from ESI to regular health insurance?
ESI generally applies to employees earning up to ₹21,000/month (thresholds can differ for employees with disabilities). Once an employee's wages exceed the applicable threshold, ESI contributions cease for that employee going forward. Many employers then offer group medical insurance to maintain coverage continuity.
How is Form 16 different from Form 16A?
Form 16 is the annual TDS certificate issued by employers to employees for tax deducted from salary (Section 192 for FY2025-26). Form 16A is the TDS certificate for non-salary payments — rent, professional fees, contractor payments — deducted under other TDS sections. Under the Income-tax Act, 2025 (effective 1 April 2026), the salary certificate becomes Form 130 and the underlying section becomes 392 for TDS deducted from FY2026-27 onward; the non-salary certificate is renumbered correspondingly. Confirm the applicable form for the financial year in question.
Do startups and small businesses need a separate payroll software from day one?
Not necessarily. A well-maintained spreadsheet-based payroll register can work for very small teams, but as headcount grows past a handful of employees, dedicated payroll software (or an outsourced payroll processor) reduces the risk of computation errors and missed statutory deadlines, and typically pays for itself in saved compliance time.
What happens if PF or ESI contributions are deposited late?
Late PF deposits attract interest and can also attract damages calculated on the delayed amount, with the rate depending on the length of delay, under the Code on Social Security, 2020 (in force since 21 November 2025, consolidating the former EPF & MP Act and ESI Act provisions). Late ESI deposits similarly attract interest. Repeated delays increase the likelihood of an EPFO or ESIC inspection or show-cause notice, so treat the 15th-of-the-month deadline as firm.
Can Professional Tax be recovered from the employee?
Yes — Professional Tax is a state-levied tax on employment/professions, and the standard practice is for the employer to deduct it from the employee's salary each month and remit it to the state government, acting as the collecting agent.
Is a written employment contract required before running payroll?
While not always a strict legal precondition to run payroll, a written offer letter or employment contract specifying CTC breakup, designation, and terms is strongly advisable — it is the reference document for salary structuring, dispute resolution, and is often requested during statutory inspections.
How are bonuses and variable pay taxed for TDS purposes?
Bonuses and variable pay are treated as part of salary income and are subject to salary TDS (Section 192 of the Income-tax Act, 1961 for FY2025-26; Section 392 of the Income-tax Act, 2025 from FY2026-27) in the month they are paid or credited. Employers typically annualize the projected total income (including expected bonus) to compute the correct monthly TDS, then true up when the actual bonus amount is confirmed.
What records should be retained for a payroll compliance audit?
Retain monthly payroll registers, PF ECR and ESI challans, Professional Tax challans, TDS deposit challans and Form 24Q filings, Form 16s issued, employee KYC and investment declarations, and attendance/leave records. Statutory retention periods vary by law, so as a practical matter most firms keep at least the last several years of records readily accessible.
Does PNPC Global handle multi-state payroll compliance?
Yes — for businesses with employees across multiple Indian states, PNPC Global coordinates state-specific Professional Tax registrations, Shops & Establishment compliance, and consolidated monthly payroll processing so filings across states stay aligned to their respective due dates.
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