Payroll in India: A Comprehensive Guide

As payroll professionals who have navigated the complexities of Indian payroll systems, we present this comprehensive guide on payroll in India. This article delves into the intricacies of the Indian payroll framework, exploring its unique features, key differences from the US system, and the crucial labor laws that shape it. Whether you're a multinational corporation expanding into India, a local business owner, or an HR professional seeking to deepen your understanding, this guide offers valuable insights drawn from practical experience and extensive research.

What are the key components of the compensation structure in India?[toc=Payroll Components]

As an Indian payroll expert advising global businesses, we've observed that the compensation structure in India is quite intricate.

Here's a breakdown of the key components: 

1. ‍Basic Salary‍: The foundation of an employee's compensation package, typically 40-50% of the total salary. It's used to calculate other allowances and benefits, is subject to income tax, and forms the basis for retirement benefits like Provident Fund and Gratuity.
2. House Rent Allowance (HRA): A significant component designed to help employees meet housing expenses. It usually ranges from 40% to 50% of the basic salary and is partially tax-exempt, depending on the city of residence and actual rent paid.
3. Conveyance Allowance‍: Provided to cover an employee's travel expenses from home to work. It's now categorized under 'Standard Deductions' with a current amount of ₹50,000 per annum (approximately $600), helping reduce the taxable income of the employee.
4. ‍Leave Travel Allowance (LTA): Offered to cover travel expenses for employees and their families for domestic travel. It's tax-exempt for up to two journeys in a block of four calendar years, but only for actual travel costs.
5. ‍Medical Allowance: Meant to cover medical expenses of the employee. It's tax-free up to ₹15,000 per annum (approximately $180), with some companies offering it as reimbursement against actual medical expenses incurred.
6. ‍Special Allowance‍: A flexible component used to balance the CTC after accounting for other components. It's usually fully taxable.
7. ‍Flexible Benefits Plan: Many international companies we work with are keen to implement these customizable packages, which can include health and life insurance, Employee Stock Options (ESOPs), additional retirement benefits, meal vouchers, gadget allowances, and education allowances. Flexible benefits plan are often tax-efficient and can be tailored to suit individual employee needs.
8. ‍Performance Bonus or Variable Pay‍: A performance-linked component based on individual, team, or company performance. It can be a significant portion of the total compensation in some roles and is taxed as per the regular income tax slab.
9. ‍Cost to Company (CTC)‍: The total cost incurred by the company for an employee, including all direct and indirect benefits. It's often higher than the actual take-home salary due to various deductions and non-cash benefits.

Understanding these components is crucial for structuring a competitive and tax-efficient compensation package while paying employees in India. The exact composition of these components can vary based on company policies, industry standards, and individual negotiations.

Accurate payroll processing is just as important as salary structuring. Paystub in India: What Employers Need to Know is key to understanding payslip formats, statutory details, and compliance essentials.

13th Month Pay

In India, the concept of a 13th-month salary is not mandatory but some companies offer it as an additional benefit. It's typically equivalent to one month's basic salary and is often paid as a festive bonus or performance incentive. While not legally required, it has become a common practice in many sectors to boost employee morale and retention.

How is payroll calculated in India?[toc=Payroll Calculation]

As an Indian payroll expert with extensive experience advising global businesses, I can confirm that payroll calculation in India follows a systematic process. The fundamental formula for calculating an employee's take-home pay is:

Net Pay = Gross Salary - Deductions

Here's a more detailed breakdown of this calculation:

• Gross Salary Computation: Gross Salary = Basic Salary + HRA + Other Allowances + Bonuses
• Deductions: Deductions = Income Tax + Provident Fund + Professional Tax + Other Statutory Deductions
• Net Pay Calculation: Net Salary = Gross Salary - (PF + ESI + Professional Tax + Income Tax + Other Deductions)

To ensure accurate calculations and compliance with Indian regulations, we recommend using specialized tools. Our Salary Calculator can help you compute the Cost to Company for your employees in India and simplify your payroll calculations.

What are the key statutory deductions and contributions in Indian payroll?[toc=Statutory Payroll Contributions]

As an Indian payroll expert advising global businesses, we've observed that statutory deductions and contributions play a crucial role in Indian payroll management.

Here are the key components:

1. Provident Fund (PF)

The Employee Provident Fund is a retirement savings scheme mandated by law. Both employers and employees contribute 12% of the employee's basic salary and dearness allowance to the PF account. This applies to establishments with 20 or more employees. The employee’s contribution is deducted from their salary, while the employer’s contribution is in addition to the salary. PF contributions are eligible for tax deductions under Section 80C of the Income Tax Act.

2. Employee State Insurance (ESI)

When advising international businesses, we emphasize the importance of Employee State Insurance (ESI) as a self-financing social security and health insurance scheme. It's mandatory for establishments with 10 or more employees and applies to those earning up to ₹21,000 per month. The employer contributes 3.25% of the employee's wages, while the employee contributes 0.75%. ESI provides various benefits, including medical care, sickness benefits, and maternity benefits.

‍3. Income Tax

One of the most complex aspects we explain to foreign companies is the Indian income tax system. It is a primary statutory deduction calculated based on an employee's earnings and applicable tax rates. The amount withheld depends on the individual's income level and tax bracket. Employees can choose between two tax regimes: the old and the new. The new tax regime has six different levels of tax rates. For example: If you earn up to INR 4,00,000, you don’t have to pay any tax. For every additional INR 4,00,000 you earn, the tax rate goes up by 5%.

‍Surcharge for New Tax Regime:

• 10% if income exceeds INR 50 lakhs but not INR 1 crore
• 15% if income exceeds INR 1 crore but not INR 2 crore
• 25% if income exceeds INR 2 crore (the maximum surcharge rate has been reduced from 37% to 25%)

Note:

• Under the new regime, due to the higher standard deduction and increased rebate, the tax liability for most salaried individuals up to ₹12.75 lakh is zero.
• The new regime is generally more beneficial for those who do not claim large deductions and exemptions, while the old regime may be better for those who can utilize significant deductions under sections like 80C, 80D, HRA, etc.

In comparison, the old tax regime offers 4 levels of tax rates with a 0% tax rate for income of up to INR 250,000. It allows various deductions and exemptions.

Surcharge for Old Tax Regime:

• 10% if income exceeds INR 50 lakhs but not INR 1 crore
• 15% if income exceeds INR 1 crore but not INR 2 crore
• 25% if income exceeds INR 2 crore but not INR 5 crore
• 37% if income exceeds INR 5 crore

Additionally, a 4% Health and Education Cess is applied to the tax amount after adding surcharges in both regimes.

To help employees better understand their take-home pay, check out the Income Tax Calculator India for 2025-26, a handy tool to estimate tax liabilities and plan finances more effectively.

4. Professional Tax

In our consultations with global HR teams, we often highlight that professional tax is a unique aspect of Indian payroll. It is a tax levied by state governments on salaried individuals, professionals, and businesses. The tax rates and slabs vary from state to state. In most states, employers are responsible for deducting professional tax from their employees' salaries and remitting it to the state government.

What are the stages of payroll processing in India?[toc=Payroll Processing Stages]

When paying employees in India, it's crucial to follow a structured process to ensure accuracy, compliance, and timely payments.

Here's an overview of the key steps:

1. Pre-payroll Activities

In the pre-payroll stage, employers gather all necessary information to ensure accurate payroll calculations. This includes collecting employee attendance records, leave data, details of new joiners and exits, salary revisions, and any loan or advance requests. It's also essential to update payroll-related policies to comply with current labor laws and conduct a statutory compliance check to verify adherence to regulations.

2. Actual Payroll Processing

During this stage, employers calculate the gross salary for each employee by adding basic salary, allowances, and bonuses. Following this, they apply all necessary deductions, such as Provident Fund (PF), Professional Tax, and Income Tax (TDS). We have guided numerous organizations through this calculation process to ensure accuracy and compliance with tax regulations. The net salary is then determined by subtracting total deductions from the gross salary.

3. Post-payroll Activities

In the post-payroll stage, employers focus on disbursing salaries to employees' bank accounts through chosen methods like electronic funds transfer or direct deposit. They also handle statutory payments by remitting deductions and contributions to appropriate authorities. Additionally, this stage includes generating and distributing payslips to employees, maintaining updated payroll records for audits, and preparing necessary compliance filings to meet regulatory requirements.

What are the payroll changes in India?[toc=Payroll Changes]

Payroll isn’t static. Every month, HR teams deal with updates like new joiners, exits, bonuses, or reimbursements that directly impact salary payouts. Managing these payroll changes correctly keeps your company compliant and avoids errors in tax deductions and employee payments.

1. Onboarding: When adding a new employee, collect accurate employee data such as PAN, Aadhaar, bank details, and previous employment records. Missing or incorrect details can lead to wrong TDS deductions and delayed salaries. Using an employee self-service portal helps automate this step and reduce manual errors.
2. Offboarding: During exits, calculate final settlements that include unpaid salary, gratuity, bonuses, and leave encashment. Delays or errors can violate the Payment of Wages Act and cause non-compliance. Always close out PF and ESI accounts promptly.
3. Loss of Pay (LOP): When employees take unpaid leave, payroll must adjust salaries accordingly. Incorrect attendance data or manual errors often cause mismatched payouts. Integrating attendance tracking with payroll software ensures accuracy.
4. Bonuses: Annual or performance-based bonuses must follow the Payment of Bonus Act and be included in tax deductions. Misreporting bonuses can lead to errors in PF and TDS filings. Automated payroll tools simplify these one-time payments.
5. Reimbursements: Expenses like travel, meals, or medical claims need to be verified and processed in payroll. Late submissions or manual tracking often delay payments and create compliance gaps. A digital claim system ensures faster approvals and accurate records.
6. Arrears: Salary arrears occur when pay revisions are backdated or payments are missed. They can impact PF, ESI, and income tax if not adjusted in the same financial year. Always process arrears promptly to stay compliant with the Income Tax Department.
7. Salary Updates: Promotions or increments must reflect in the payroll system immediately. Missing updates lead to incorrect tax deducted at source (TDS) and wrong employer contributions. Cross-check all changes before processing payroll each month.

‍How to set up payroll in India?[toc=How to Set Up Payroll]

Setting up payroll in India might seem like a lot at first, but once you break it down step by step, it’s much easier to manage. Let’s walk through the key steps to get your payroll process running smoothly and ensure you're ticking all the compliance boxes:

Step 1: Apply for TAN (Tax Deduction and Collection Account Number)

Before initiating payroll operations, employers must obtain a TAN from the Income Tax Department. This unique 10-digit alphanumeric code is essential for deducting and depositing TDS (Tax Deducted at Source) from employee salaries. In my experience, applying online through the NSDL website is the most efficient method, though you can also submit Form 49B to your local tax office if needed. Once obtained, the TAN must be quoted on all TDS returns and challans.

Step 2: Collect Employee Details

Gather comprehensive information from each employee, including personal details, PAN (Permanent Account Number), bank account information, and any investment declarations for tax-saving purposes. This data is crucial for accurate salary calculations and statutory compliance. Ensure you have a secure system in place to store and manage this sensitive information in compliance with data protection regulations.

Step 3: Establish your payroll process and policies

Decide whether to manage payroll in-house or outsource to a specialized service provider. While in-house offers more control, we've seen many companies benefit from outsourcing to specialized providers. In-house processing offers more control but requires significant expertise and resources to stay compliant with ever-changing regulations. Outsourcing to firms can be cost-effective and ensures compliance, allowing you to focus on core business activities. Whichever option you choose, clearly document your payroll policies, including pay periods, leave policies, and overtime calculations.

Step 4: Payroll Calculation

Compute the gross salary for each employee, factoring in basic pay, allowances, and any variable components. Then, calculate all applicable deductions, including TDS, Provident Fund, Professional Tax, and any other company-specific deductions. Ensure your calculations comply with the latest tax slabs and labor laws.

Common payroll errors include incorrect or incomplete employee details, missed LOP entries, unadjusted arrears, delayed salary updates, and manual data entry that causes mismatched statutory payments.

Step 5: Salary disbursement and payslip issuance

Process salary payments through your chosen method, typically electronic transfers like NEFT or RTGS.  Generate and distribute detailed digital payslips to employees within the first week of the following month, clearly breaking down salary components, deductions, and net pay. Maintain accurate records of all transactions for auditing and potential discrepancy resolution.

If you want to minimize payroll errors and simplify the entire process, start by using reliable payroll software or services. Check out our article on “Best Payroll Software in India” to find the right fit for your business.

Payroll Cycle in India

In India, the most common pay period is monthly, with salaries typically disbursed on the last working day of the month or within the first few days of the following month. While some industries or specific roles (like daily wage workers) might have weekly or fortnightly pay cycles, these are exceptions rather than the norm. 

Salary Disbursement Methods

When it comes to salary disbursement methods in India, we've guided numerous organizations through the process of selecting and implementing the most suitable options. Here's an overview of the primary methods, based on my extensive experience in payroll management:

Top 5 Salary Disbursement Methods in India: EFT, Direct Deposit, Salary Cards, Cheques & Cash

1. Electronic Funds Transfer (EFT): Most common method, including NEFT, RTGS, or IMPS.
2. Direct Deposit: Salary credited directly to employee bank accounts.
3. Salary Cards: Pre-loaded cards, useful for unbanked employees.
4. Cheques: Less common now, but still used in some small businesses.
5. Cash: Rare, mainly for daily wage workers in informal sectors.

What are the Leave Policies and Paid Time Off Regulations in India?[toc=Leave Policies in India]

Understanding leave policies is crucial when paying employees in India. These policies affect employee compensation and ensure compliance with Indian labor laws. As an experienced payroll consultant who has guided numerous organizations through the complexities of leave policies and overtime regulations in India, we can provide valuable insights into these crucial aspects of employee compensation. Here's an overview of the main types of leave:

Types of Leave in India:

1. Earned Leave (EL): 15-30 days annually
2. Casual Leave (CL): 7-10 days annually
3. Sick Leave (SL): 7-14 days annually
4. Maternity Leave: 26 weeks for first two children
5. Paternity Leave: Company-specific, usually 5-15 days
6. Public Holidays: 10-14 days annually, varies by state

Impact on Payroll Calculations:

1. Paid leaves treated as working days for salary calculation
2. Unpaid leaves deducted from monthly salary
3. Leave encashment taxed as salary income
4. Extended unpaid leaves may affect PF and ESI contributions
5. Accurate leave tracking crucial for correct payroll processing

Key Considerations:

Having implemented leave policies for organizations of various sizes, we strongly recommend:

• Maintain clear leave policies
• Implement robust leave management system
• Ensure compliance with state-specific regulations
• Regularly update payroll systems to reflect leave policy change

What are the Regulations on Overtime and Working Hours in India?[toc=Overtime Working Hours]

In our role advising companies on labor law compliance, we've found that understanding overtime regulations is critical to avoid legal issues and ensure fair compensation.

Regulations on Working Hours:

• Standard working hours: 8-9 hours per day, 48 hours per week
• Maximum daily limit: 12 hours (including overtime)
• Mandatory rest breaks: Usually after 5 hours of continuous work
• Weekly limit: 48 hours (can extend to 54 hours in special circumstances)

Overtime Calculation and Limits:

• Definition: Work beyond standard hours (over 8-9 hours/day or 48 hours/week)
• Overtime rate: Generally twice the ordinary rate of wages
• Formula: (Hourly Rate x 2) x Number of Overtime Hours
• Limits: Varies by industry; generally should not exceed 50 hours per quarter

Based on our experience overseeing payroll for large corporations, accurate overtime calculation is essential for compliance and employee satisfaction.

Key Considerations:

Having guided numerous organizations through overtime policy implementation, we recommend:

• Accurate tracking of regular and overtime hours
• Proper application of overtime rates
• Compliance with industry-specific and state-specific regulations
• Regular updating of payroll systems to reflect regulatory changes

Want the full breakdown? Read our article on Legal Working Hours & Overtime Pay Rules in India.

How are termination and final settlement handled in Indian payroll?[toc=Termination & Final Settlement]

Having managed numerous terminations and final settlements for companies across India, we can provide valuable insights into this critical process. When an employee's tenure ends, the payroll process in India involves specific steps for termination and final settlement. Here's what you need to know:

Notice Period Requirements:

In our experience overseeing HR departments, notice periods typically range from 1-3 months, as specified in the employment contract or company policy.

• Typically 1-3 months, as per employment contract or company policy
• Mandatory as per Industrial Disputes Act for workmen in certain establishments
• Can be waived or shortened by mutual agreement

Calculation of Final Pay:

Having processed countless final settlements, we can attest to the complexity of this calculation. The final pay typically includes:

1. Regular salary for days worked
2. Payment for unused leave (as per company policy)
3. Gratuity (if eligible - 5+ years of continuous service)
4. Bonus/incentives (if applicable)
5. Reimbursements of pending expenses
6. Provident Fund settlement (employee's share + interest)

For more detailed information, visit our "How to Terminate a Remote Employee in India" article.

What are the challenges faced when managing payroll in India?[toc=Common Challenges]

Managing payroll in India can be complex due to various compliance issues and statutory requirements. Common challenges include:

1. Compliance with constantly changing payroll regulations at both the central and state governments level.
2. Calculating payroll for employees working in different states with varying minimum wage rates and statutory deductions.
3. Manual processes can be time-consuming and error-prone, especially when handling employee data manually. This increases the risk of non-compliance.
4. Tax deductions are complicated, especially for foreign businesses managing international payroll. Ensuring compliance with income tax and professional tax rules is crucial.
5. Managing employee benefits like maternity benefit, leave policies, and health insurance involves ensuring compliance with various laws, including the Maternity Benefit Act and Employees' State Insurance Act.

Many companies are moving towards automated payroll systems to save time and reduce the risk of errors. Payroll software makes managing complex deductions and statutory contributions easier, improving payroll compliance and ensuring that companies stay compliant with all payroll regulations.

How does Wisemonk help with payroll in India?[toc=How Wisemonk Helps]

Wisemonk is a leading Employer of Record (EOR) in India service provider that empowers global businesses to hire, pay and manage employees in India without establishing a local entity. Wisemonk handles wage calculations, tax withholdings, deductions, direct deposits, and generation of detailed pay statements.

Key core services of Wisemonk:

1. Recruitment: End-to-end hiring support from screening and assessments to interview coordination and final selection to help you find top talent fast.
2. Payroll Processing: Fully managed payroll with tax optimization, local compliance, and automated payslips that are error-free and on time.
3. Dedicated HR Support: Onboarding made easy with document collection, background checks, and policy setup for consistent HR operations across your team.
4. Contractor Management: Seamless contractor payments and compliance with local laws, plus tools to track and manage your freelance workforce.
5. Compliance: Stay compliant with Indian tax, labor, and statutory laws. We manage filings, updates, and audits so you don’t have to.
6. Equipment Management: We lease, track, and recover work equipment for remote and on-site teams, ensuring everyone has what they need to stay productive.

Wisemonk provides a one-stop solution for companies looking to build and manage teams in India. Whether you're a startup or an established company, Wisemonk simplifies the complexities of Indian Payroll management, allowing you to focus on growth and innovation. Contact Wisemonk today. 

FAQs

How much does it cost to run payroll in India?

The cost of running payroll in India varies depending on factors such as the number of employees and the complexity of payroll calculations. While exact costs differ, using a specialized service like Wisemonk can often be more cost-effective than managing payroll in-house. For detailed pricing information, visit Wisemonk's Pricing page.

What is TDS and how is it calculated?

TDS (Tax Deducted at Source) is a method of collecting income tax from employees' salaries by deducting it directly at the time of payment. It is calculated based on the employee's taxable income slab as per the Income Tax Act. Employers must remit TDS to the government monthly and issue Form 16 annually.

How often should payroll be processed?

Payroll process in India is typically done monthly in India, aligning with most companies' salary disbursement cycles. Some organizations may choose bi-weekly or weekly processing based on industry practices or specific employee agreements.

Can I manually run payroll for workers in India?

While it's possible to manually run payroll in India, it's time-consuming and prone to errors due to complex tax regulations and frequent changes in labor laws. Many businesses find it more efficient and compliant to use specialized services like Wisemonk, which handle all aspects of payroll processing and ensure adherence to local regulations.

How do you pay contractors in India?

Contractors in India are typically paid through bank transfers based on submitted invoices. It's crucial to have clear contracts and comply with tax regulations, including withholding tax (TDS) where applicable. Wisemonk offers contractor payment services that manage these complexities, ensuring compliant and timely payments.

How do foreign businesses pay remote employees in India?

Foreign businesses can pay remote employees in India through services like Wisemonk, which handle currency conversion, compliance with local regulations, and ensure payments are made in Indian Rupees (INR). Wisemonk's Employer of Record (EOR) services simplify this process, managing all aspects of employment and payroll for remote workers in India.

What are the penalties for non-compliance with payroll regulations?

Non-compliance with payroll regulations can result in penalties ranging from fines to legal action against the company. These penalties vary depending on the nature of non-compliance, such as late payment of statutory dues or incorrect tax deductions. Ensuring timely compliance helps avoid these issues.

What are the key differences between Indian and US payroll systems?

Indian and US payroll systems differ primarily in tax structure, pay frequency, and employee benefits. In India, employees are typically paid monthly, with tax deductions based on a progressive tax slab system (TDS). In contrast, US employees are often paid bi-weekly or semi-monthly, with federal, state, and local taxes deducted based on a W-4 form. Social security contributions also vary; India has the Employees' Provident Fund (EPF) and Employees' State Insurance (ESI), while the US has Social Security and Medicare. Additionally, overtime pay in India is double the regular rate, whereas, in the US, it's 1.5 times the regular wage.

What are the currency and foreign exchange regulations for payroll in India?

In India, payroll must be paid in Indian Rupees (INR). For foreign companies, payments are processed in INR, and employees can repatriate their earnings abroad through RBI-approved banks. The Foreign Exchange Management Act (FEMA) governs these transactions, ensuring compliance with Indian regulations. Employees working for foreign firms must provide necessary documentation like PAN and follow exchange rate procedures when transferring funds internationally.

What are the best payroll tools to use for businesses in India?

Some of the best payroll tools for businesses in India include Zoho Payroll, Keka, GreytHR, QuickBooks Payroll, and ADP India, all of which automate salary calculations, tax deductions, and statutory compliance like PF, ESI, and TDS. For global companies without a local entity, Wisemonk acts as an Employer of Record (EOR), managing end-to-end payroll, compliance, and employee benefits to simplify hiring and payments in India.

How is payroll processing done in India?

Payroll processing in India involves several steps: Pre-payroll activities include collecting attendance data and calculating gross salary; Payroll processing involves calculating deductions (like TDS and PF); Post-payroll activities include disbursing salaries and filing statutory returns.