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.
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)
- Professional Tax registration in the relevant state
- Salary structure for each employee (CTC breakup: basic, HRA, allowances, PF, ESI)
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 (40–50% of CTC), HRA (50% of Basic for metro, 40% for non-metro), LTA, Special Allowance, and employer PF/ESI contributions. The structure determines TDS liability and statutory deductions.
Register for All Statutory Obligations
Ensure the company has: EPF PF Code from EPFO, ESI Sub-code from ESIC, Professional Tax registration from the state commercial tax authority, and TAN for TDS deduction. These registrations must be in place before the first payroll run.
Collect Employee KYC and Tax Declarations
Collect Form 12BB from each employee at the start of the financial year — this declares their investment proofs (80C, 80D, HRA, LTA) that reduce their taxable salary. Collect PAN, Aadhaar, bank account, and UAN details for payroll records.
Run Monthly Payroll Computation
Each month, compute: gross salary, statutory deductions (PF: 12% of basic+DA, ESI: 0.75% of gross for employees earning ≤₹21,000), Professional Tax, and TDS. The employer also contributes: PF: 12% of basic+DA, ESI: 3.25% of gross.
Disburse Salary and Issue Payslips
Transfer net salary to employees' bank accounts by the agreed pay date. Issue a detailed payslip showing gross salary, all deductions, and net take-home. Payslips are required by the Payment of Wages Act and are essential for employees' loan and visa applications.
File Monthly Statutory Challans
By the 15th of each month, deposit PF contributions (ECR on EPFO portal), ESI contributions (ESI portal), and Professional Tax challan (state portal). TDS (Form 24Q for salary) must be deposited by the 7th of the following month and a quarterly return filed by the prescribed date.
Common mistakes to avoid
- Excluding allowances from ESI contribution — all earnings (except HRA, overtime in some states, and reimbursements) form part of gross wages for ESI calculation.
- Not collecting Form 12BB before paying salary — without investment declarations, you must deduct TDS at the slab rate without any 80C/HRA deductions, leading to excess deduction disputes.
- Missing PF ECR deadlines — late PF deposits attract 12% per annum interest plus damages up to 25% of arrears under the EPF Act.
- Issuing salary in cash for amounts above ₹10,000 — the Payment of Wages Act requires bank transfer for salaries above this threshold in most states.
Frequently asked questions
Is EPF mandatory even if employees' salaries are above ₹15,000?
Employees earning above ₹15,000 basic+DA are exempt from mandatory EPF contribution. However, existing members can continue voluntarily, and the employer must continue contributions for them. New high-earners can opt out.
What is the difference between CTC and gross salary?
CTC (Cost to Company) includes all cash components plus employer's statutory contributions (PF, ESI, gratuity provisioning). Gross salary is the total pay before statutory deductions but after employer contributions are excluded. Take-home (net salary) is gross minus employee-side deductions (PF, ESI, PT, TDS).
When must a company switch from ESI to regular health insurance?
ESI applies to employees earning up to ₹21,000/month. Once an employee's salary exceeds this, ESI contributions cease. Many companies then offer group medical insurance to cover the gap.
How is Form 16 different from Form 16A?
Form 16 is the TDS certificate issued by employers to employees for tax deducted from salary (under Section 192). Form 16A is the TDS certificate for non-salary payments (rent, professional fees, etc.) where TDS was deducted under other sections.
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