HomePayroll Processing Guide

Payroll Processing in India: Steps, Compliance and Employer Responsibilities

Payroll in India is not just salary disbursement. It is a chain of interdependent steps, each with its own statutory deadline and compliance obligation. A delay or error at any point in the chain creates downstream problems: incorrect Form 16, missed PF deposits, disputed payslips. This reference covers all ten steps, what each one involves, and where the common failure points are.

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Step 1: Collection of Employee Data

Before a single calculation can be run, payroll needs three verified inputs for each employee: their statutory identifiers, their salary structure, and their attendance record for the pay period. Missing or incorrect data at this stage propagates through every subsequent step and is the most common cause of payroll errors that surface only after the salary has already been credited.

Statutory identifiers, specifically PAN and UAN, must be collected at joining and verified against the employee's documents. PAN governs TDS computation. UAN governs PF deposits. An incorrect PAN results in TDS being deducted at the wrong rate. An unactivated or mislinked UAN means PF contributions cannot be deposited against the correct account. Both issues are time-consuming to correct after the fact.

Attendance data for the pay period feeds directly into the salary calculation: days worked, leave taken, overtime, and any loss of pay days. The quality of this data depends on whether the attendance system captures it in a format that payroll can consume without manual intervention. Manual attendance records are the single largest source of payroll discrepancies in Indian SMEs.

Employee identifiers. Employee ID, full name as per Aadhaar and PAN, date of joining, department, and work location. All of these appear on the payslip and must match the employee record exactly.
PAN and UAN. Required before the first payroll run. PAN must be verified; UAN must be activated and seeded against Aadhaar. Employees without a PAN are subject to TDS at a higher flat rate.
Bank account details. Account number, IFSC code, and account holder name must be verified. A salary credited to the wrong account is a significant recovery problem, particularly if the employee no longer works at the company.
Salary structure. Basic pay, HRA, special allowances, and any variable components must be confirmed before the pay period opens. Mid-period salary revisions require a prorated calculation and should be documented with a signed increment letter before taking effect in payroll.
Attendance and leave data. Days present, leave taken by type, overtime hours, and any loss-of-pay days. Leave type matters: earned leave encashment has a different treatment from casual leave, and unpaid leave affects PF contribution calculations.

Step 2: Salary Calculation

Salary calculation moves in one direction: start with gross pay, apply each deduction in sequence, arrive at net pay. The deductions are a mix of statutory obligations and company-specific items, and the order matters for some calculations.

Gross salary

Gross salary is the sum of all pay components before deductions: basic salary, HRA, special allowances, performance bonus if applicable in that pay period, and any other fixed or variable components. Under the New Labour Codes effective November 2025, basic salary must be at least 50 percent of total gross compensation. This rule constrains how allowances can be structured and directly affects PF, ESI, and gratuity calculations, all of which use basic salary as their base.

Provident Fund deduction

The employee contributes 12 percent of basic salary to the Provident Fund each month. The employer contributes a matching 12 percent, of which 8.33 percent goes to the Employees Pension Scheme subject to a wage ceiling of Rs 15,000 per month, and 3.67 percent goes to the EPF account. Both contributions are calculated on basic salary. If the employee's basic salary exceeds the statutory ceiling, contributions can be limited to the ceiling amount unless the employee opts to contribute on the full salary.

ESI deduction

For employees with a gross monthly salary up to Rs 21,000, the employee contributes 0.75 percent of gross wages and the employer contributes 3.25 percent to the Employee State Insurance Corporation. ESI coverage provides medical, sickness, maternity, and disability benefits. Once an employee's salary crosses the Rs 21,000 threshold mid-year, contributions continue until the end of that contribution period. New employees must be registered with ESIC within ten days of joining.

Professional tax and TDS

Professional tax is levied by states that have enacted it and is deducted based on the salary slab specified by that state. The applicable slab is determined by the employee's state of work location, not their home state. TDS is calculated based on the employee's projected annual income for the financial year, their declared investments under sections 80C, 80D, and others, and their HRA exemption if applicable. The monthly TDS deduction is the estimated annual tax divided by twelve, adjusted for any variance in the employee's income during the year.

Step 3: Tax Compliance

Tax compliance in payroll has three distinct obligations: computing the correct TDS each month, collecting and processing employee investment declarations, and filing quarterly TDS returns with the income tax department. All three must work together. An error in the investment declaration processing affects the TDS computation, which in turn affects the quarterly return, which determines what appears on the employee's Form 16 at year end.

At the start of the financial year, employees submit Form 12BB declaring their planned investments and HRA claims. Payroll uses these to project the annual tax and divide it into monthly TDS installments. Before the year ends, employees submit actual proofs. Where the proofs fall short of the declaration, the shortfall must be recovered in the remaining months. Where they exceed it, the excess TDS can be adjusted. The final TDS figure for the year feeds directly into Form 16.

TDS must be deposited with the income tax department by the 7th of the following month for all months except March, where the deadline is 30 April. Quarterly returns are filed using Form 24Q. Delays in deposit attract interest, and errors in the return require rectification filings that create additional administrative overhead.

Form 12BB. The investment declaration form submitted by employees at the start of the financial year. Covers rent paid for HRA exemption, interest on housing loan, life insurance premiums, PPF contributions, and other 80C investments. Payroll cannot compute TDS accurately without it.
Investment proof collection. Actual documentary proofs are collected before the year ends, typically in January or February. Any gap between declared and proven amounts must be recovered in the final months of the year to avoid a large deduction in March.
Form 24Q filing. The quarterly TDS return filed by the employer with the income tax department. Contains details of every employee's salary and TDS deducted for that quarter. Must be filed by 31 July, 31 October, 31 January, and 31 May for the four quarters respectively.
Form 16 issuance. The annual TDS certificate issued to each employee by 15 June following the end of the financial year. Part A shows the TDS deposited; Part B shows the salary and deduction details. Employees cannot file their income tax return without it.
New tax regime vs old tax regime. Employees must declare their preferred tax regime at the start of the year. The two regimes have different slab rates and exemption structures. The choice affects which deductions payroll can apply when computing TDS. An employee who does not declare is defaulted to the new regime under current rules.

Step 4: Statutory Contributions and Filings

Statutory contributions are not optional line items. They are legal obligations with their own deposit deadlines, interest for late payment, and penalties for non-compliance. The employer is responsible for both the employer share and for deducting and remitting the employee share.

PF deposits and ECR filing
Both employee and employer PF contributions must be deposited with the EPFO by the 15th of the following month. The employer files the Electronic Challan cum Return, known as ECR, through the EPFO unified portal each month. The ECR maps each contribution to the employee's UAN. Late deposits attract interest at 12 percent per annum under the EPF Act. The employer must also pay administrative charges of 0.5 percent of wages to the EPFO and contribute 0.5 percent to the Employees Deposit Linked Insurance scheme.
ESI contribution and filing
ESI contributions, both employer and employee shares, must be deposited with the ESIC by the 15th of the following month. Employers file monthly contribution returns through the ESIC employer portal. Each covered employee must have an active ESI Pehchan card. When a new employee joins and falls within the ESI wage ceiling, they must be registered with ESIC within ten days of joining. Failure to register or remit on time attracts interest and can result in the employer being required to bear the cost of any ESI benefits the employee should have received.
Professional tax
Professional tax is deposited with the state government on a monthly or quarterly basis depending on the state. The applicable rate is determined by the employee's salary slab under the state's professional tax schedule. States that levy professional tax include Maharashtra, Karnataka, West Bengal, Andhra Pradesh, and Telangana, among others. The employer deducts the tax from the employee's salary and remits it to the state. Non-compliance attracts state-specific penalties.
Gratuity provisioning
Gratuity is not deducted from the employee's salary. It is an employer obligation that accrues over time. For employees approaching five years of continuous service, the employer should be setting aside a provision each month. The calculation is: last drawn basic salary multiplied by 15, multiplied by years of service, divided by 26. Under the New Labour Codes, fixed-term employees earn proportional gratuity from year one. Gratuity is paid at the time of separation and must be settled within thirty days of the employee's exit.

Step 5: Payroll Compliance with Labour Laws

Several statutes impose specific obligations on payroll beyond the contribution and filing requirements. Each one has its own compliance trigger and timeline.

Minimum wages

The Minimum Wages Act requires that every employee receives at least the minimum wage prescribed by their state for their category of work. Minimum wages vary by state, industry, and skill category. They are revised periodically. Payroll must be checked against the applicable rate before each cycle, particularly in states where revisions occur twice a year. Paying below minimum wage, even inadvertently, is a statutory violation that can result in penalties and back-pay obligations.

Payment of Wages Act timelines

Under the Payment of Wages Act, wages must be paid by the 7th of the following month for establishments with fewer than 1,000 employees, and by the 10th for larger ones. Wages cannot be deducted except for reasons specifically permitted by the Act. Any deduction not covered by the Act, including arbitrary deductions for errors, breakages, or absences beyond what is contractually permitted, is a violation. The employer must also maintain a wage register in the prescribed format.

Statutory bonus

The Payment of Bonus Act mandates an annual bonus for employees in establishments with twenty or more workers, where the employee's salary does not exceed Rs 21,000 per month. The minimum bonus is 8.33 percent of annual wages or Rs 100, whichever is higher. The maximum is 20 percent. Bonus must be paid within eight months of the close of the accounting year. Whether this is treated as a payroll item or a separate disbursement, it must be accounted for in the financial year it accrues.

Maternity and leave encashment

The Maternity Benefit Act mandates paid leave of up to 26 weeks for eligible female employees. This is a direct payroll obligation: the employer funds the maternity benefit, not the ESI scheme, for employees above the ESI wage threshold. Leave encashment for unused earned leave must be paid at the time of exit and is calculated at the daily rate of basic salary. The formula and any caps on carry-forward must be consistent with the employment contract and applicable state law.

Steps 6 and 7: Payslip Generation and Salary Disbursal

A payslip is not a courtesy. For employees covered by the Payment of Wages Act, issuing a payslip is a legal obligation. For all employees, it is the documentary evidence of what was paid and what was deducted, and it is the record they will present to a bank, a landlord, or a visa authority when asked to prove their income.

Each payslip must itemise every deduction separately. Grouping PF and ESI together under a single line, or netting them out without disclosure, is not acceptable. The employee needs to be able to verify that the correct amount was deducted for each statutory contribution. Any error discovered at this stage is easier to correct before the salary is disbursed than after.

Salary disbursement is done via NEFT, RTGS, or IMPS directly to the employee's registered bank account. The employer should retain proof of payment for each employee for each month. Bulk salary transfers require a bank-compatible file in the format prescribed by the company's bank, usually a CSV or Excel template. Any rejection by the bank, typically due to a wrong account number or IFSC code, must be resolved and retransferred promptly to meet the Payment of Wages Act deadline.

Payslip contents. Employee name and ID, pay period, gross salary broken into components, each statutory deduction (PF, ESI, professional tax, TDS) shown separately, any non-statutory deductions, and net pay. The payslip must also show the employer's PF and ESI contributions for transparency.
Digital delivery. Payslips can be sent by email, made available on the company HR portal, or both. Password-protecting payslip PDFs, typically with the employee's date of birth, is a common and acceptable practice. What matters is that the employee can access their payslip independently and promptly.
Bank transfer file. The file submitted to the bank contains account number, IFSC code, employee name, and net salary amount for each employee. Verify this file against the payroll output before submitting. A transposition error in a bank account number results in a failed or misdirected transfer that requires a bank recall process.
Payment confirmation. The bank provides a transaction reference for each successful transfer. Retain these references and map them to the corresponding payslips. They are the proof of payment if an employee disputes whether their salary was credited.

Steps 8 and 9: Post-Payroll Activities and Record Maintenance

Once salaries are disbursed, the statutory filing cycle begins. The deadlines here are fixed and non-negotiable. Missing them creates interest obligations and, for repeated failures, can trigger inspections.

EPF and ESI monthly filings
The ECR for PF and the ESI contribution return must both be filed and the contributions deposited by the 15th of the following month. These are not the same deadline as salary payment. A company can pay salaries on the last day of the month and still have fifteen days to complete the statutory filings. However, if the payroll cycle is delayed, the filing deadline does not move. PF contribution deposits attract 12 percent per annum interest if paid late, and additional damages of up to 25 percent of arrears for persistent default.
TDS deposit and quarterly returns
TDS deducted in a month must be deposited with the income tax department by the 7th of the following month (30 April for March deductions). Quarterly TDS returns in Form 24Q must be filed by the deadlines for each quarter. If a return contains errors, a correction statement can be filed, but the process is time-consuming. Errors in PAN or challan details in the TDS return are the most common causes of discrepancies that surface in employee Form 26AS and eventually in Form 16.
Form 16 issuance
Form 16 must be issued to every employee by 15 June following the close of the financial year. It has two parts: Part A is generated from the TDS return filed with the income tax department, and Part B is the salary and deduction details compiled by the employer. Both parts must be signed or digitally authenticated. An employee cannot file their income tax return without a valid Form 16, so delays or errors in issuance create a direct obligation for the employee that the employer has caused.
Payroll record maintenance
Payroll records, covering salary registers, deduction registers, statutory contribution records, and TDS returns, must be maintained for audit purposes. The retention period varies by statute: PF and ESI records for five years, wage registers under the Payment of Wages Act for three years. A defensible practice is to retain all payroll records for seven years from the date of the last entry, which covers the audit window for most Indian statutes. Records must be in a form that can be produced during an inspection without reconstruction.

Step 10: End of Service and Full and Final Settlement

The final payroll run for a departing employee is more complex than a regular monthly cycle. Every outstanding obligation must be identified, calculated, and settled before the employment relationship is formally closed. For a detailed walkthrough of the entire exit process, see the employee exit guide.

Salary for days worked

The final month's salary is prorated to the last working day. The proration method should be consistent with the company's payroll policy: some use calendar days, others use working days. Whichever method is used must be documented and applied the same way for all employees. The prorated salary carries the same statutory deduction obligations as a full month's salary, including TDS if the projected annual income places the employee above the tax threshold.

Leave encashment

Unused earned leave that has accrued must be encashed at the time of exit. The rate is the basic salary divided by the number of working days in a month, applied to the number of leave days being encashed. Some states prescribe a specific formula under their Shops and Establishments Acts. Leave encashment paid at exit is taxable in the hands of the employee, subject to the exemption limits under the Income Tax Act for employees other than government servants. TDS must be computed on the encashment amount and deducted accordingly.

Gratuity payment

If the employee has completed five years of continuous service, gratuity must be paid within thirty days of the last working day. The formula is: (last drawn basic salary plus dearness allowance) multiplied by 15, multiplied by completed years of service, divided by 26. Gratuity up to Rs 20 lakh is exempt from income tax. Any amount above this threshold is taxable. Under the New Labour Codes, fixed-term employees are entitled to proportional gratuity from the completion of the first year of service, so the joining date and contract type must be verified before the final settlement is calculated.

Exit documents

Once the full and final settlement is processed and paid, the relieving letter and experience letter should be issued. The settlement statement itself should be provided in writing, signed by both parties. TDS on the final settlement must be deposited and reflected in the quarterly return for that period. The employee will need these figures when filing their income tax return, particularly if the final settlement spans two financial years or includes non-routine components like gratuity or notice pay in lieu.

Payroll Processing: Step-by-Step Reference

A summary of all ten steps, the key action in each, and the primary compliance deadline or obligation.

Step	Key action	Primary compliance obligation
1. Employee data collection	Verify PAN, UAN, bank details, salary structure, and attendance records	Errors here propagate through all subsequent steps; verify before payroll opens
2. Salary calculation	Compute gross salary and apply PF, ESI, professional tax, and TDS deductions	Basic salary must be at least 50% of gross under New Labour Codes (November 2025)
3. Tax compliance	Process Form 12BB declarations, compute TDS, collect year-end proofs	TDS deposited by 7th of following month; Form 24Q filed quarterly
4. Statutory contributions	Deposit PF and ESI contributions and file ECR and ESIC returns	Both deposits and filings due by 15th of following month
5. Labour law compliance	Verify minimum wages, bonus eligibility, maternity benefit accounting, leave encashment	Payment of Wages Act: salary by 7th or 10th of month; Bonus Act: payment within 8 months of year end
6. Payslip generation	Produce itemised payslips showing each deduction separately	Payslip is a legal requirement under Payment of Wages Act for covered employees
7. Bank transfer	Transfer net salaries via NEFT, RTGS, or IMPS; retain payment references	Payment must reach employee within statutory timeline; bank file must be verified before submission
8. Post-payroll filings	File EPF ECR, ESI return, and TDS deposit for the month	PF and ESI: 15th of following month; TDS: 7th of following month
9. Record maintenance	Retain salary, deduction, and statutory records in retrievable format	PF and ESI records: 5 years; wage registers: 3 years; recommended retention: 7 years
10. Full and final settlement	Calculate and pay prorated salary, leave encashment, and gratuity; issue exit documents	Gratuity must be paid within 30 days of last working day; TDS on settlement must be deposited and filed

Frequently Asked Questions

By when must an Indian employer pay salaries each month?

Under the Payment of Wages Act, wages must be paid by the 7th of the following month for organisations with fewer than 1,000 employees, and by the 10th for larger establishments. Many companies target the last working day of the month or the 1st of the following month by internal policy, which is within the statutory window.

What is the employer contribution to PF in India?

The employer contributes 12 percent of the employee's basic salary to the Provident Fund each month. Of this, 8.33 percent goes to the Employees Pension Scheme subject to a wage ceiling, and 3.67 percent goes to the EPF account. The employer also contributes 0.5 percent to the Employees Deposit Linked Insurance scheme. All contributions are routed through the EPFO portal using the employee's UAN.

When does ESI apply and what are the contribution rates?

ESI applies to employees earning up to Rs 21,000 per month in establishments with ten or more employees. The employee contributes 0.75 percent of gross wages and the employer contributes 3.25 percent. Once an employee's salary crosses the threshold mid-year, contributions continue until the end of that contribution period. ESI provides medical, sickness, maternity, and disability benefits.

What is Form 16 and when must it be issued?

Form 16 is a TDS certificate issued by the employer to each employee at the end of the financial year. It shows total salary paid, all deductions claimed, and the TDS deposited with the income tax department. Employers must issue Form 16 by 15 June following the close of the financial year. Employees use it to file their income tax returns.

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