Payroll Processing in India: Steps, Calculation and Compliance

Managing payroll in India isn’t just about sending salaries at the end of each month. It’s a layered process with calculations, deadlines, and legal checks that must be done precisely, or you risk errors because, from TDS to EPF, there’s always something to double-check.

And let’s be honest - with all the rules around PF, ESI, TDS, and state-wise differences, it’s easy to feel lost. That’s why we created this guide that breaks it all down, step-by-step, number-by-number, rule-by-rule, from start to finish.

What is payroll processing?

Payroll processing refers to the end-to-end management of employee salaries. This includes collecting employee data, calculating wages, making deductions, transferring salaries to bank accounts, and handling compliance filings.

In India, payroll is closely tied to legal obligations under the Income Tax Act, the Payment of Wages Act, the Employees’ Provident Fund and Miscellaneous Provisions Act, and other central and state-level laws. Getting payroll right ensures employees are paid on time and correctly, while helping companies stay legally compliant.

It’s a mix of HR, finance, and compliance functions, and must be done every single month without fail.

🧾 In my view, payroll isn’t just an operational task. It directly affects employee trust and your brand’s reputation as an employer.

Steps in Indian payroll processing

Payroll typically follows a monthly cycle and can be broken down into these key stages:

Pre-payroll activities

This is the preparation phase. Before running payroll, businesses need to:

• Collect employee information: PAN, Aadhaar, bank account details, address, date of joining, salary structure, etc.
• Maintain attendance and leave records: To calculate working days, overtime, and leave deductions.
• Define company policies: Including leave policy, reimbursement rules, bonus structure, and expense claims.
• Group employees correctly: Full-time staff, part-time, interns, and contractors may have different payroll structures.

🔍 Tip: Setting up a centralised employee database early on can reduce last-minute errors. 

Payroll calculation

Once the inputs are ready, it’s time to calculate salaries. The payroll team (or software) will:

• Compute gross salary based on the salary structure.
• Deduct applicable taxes and contributions (like income tax, provident fund, and professional tax).
• Finalise the net salary to be paid.

Most businesses now use payroll software like Native Teams’ Payroll Calculator or work with service providers to reduce manual work and ensure compliance.

Post-payroll activities

After salaries are calculated:

• Salaries are disbursed to employees’ bank accounts, usually via bulk bank transfers or integrated payroll platforms.
• Payslips are generated and shared, either by email or through an employee portal.
• Statutory payments are made: PF, ESI, and tax deductions are deposited with the respective government departments.
• Records are maintained for internal and external audits.

📁 We also include payroll reports in our monthly reviews to track trends like overtime hours or bonus payments.

Additional activities

Apart from the monthly cycle, payroll teams also manage:

• Mid-year tax declaration updates
• Processing resignations, final settlements, and Form 16s
• Revising salaries and issuing arrears
• Tracking statutory changes in tax or labour laws

Key components of payroll calculation

To understand how salaries are calculated, it’s useful to break down a standard Indian payslip. Here are the core elements:

Basic salary

This forms the foundation of an employee’s pay. It’s typically 40–50% of the total cost to company (CTC) and is fully taxable. Provident fund, gratuity, and other statutory benefits are calculated based on the basic salary.

Allowances

Allowances are fixed payments made in addition to the basic salary. Common types include:

• House Rent Allowance (HRA) – partly tax-exempt if rent receipts are provided
• Conveyance Allowance – for commuting costs
• Medical Allowance – tax-free up to ₹15,000/year (under specific rules)
• Leave Travel Allowance (LTA) – exempt if valid travel proof is submitted

🏡 Some companies offer flexible benefits, allowing employees to choose allowances based on their needs.

Bonuses

Bonuses can be performance-based, annual, festival-related, or retention-focused. They’re usually taxable and must be included in payslips and tax filings.

Statutory deductions

Deductions are made as per Indian laws and must be deposited with the government.

• Provident Fund (PF): 12% of basic salary, matched by the employer
• Employees’ State Insurance (ESI): 0.75% (employee) and 3.25% (employer) if gross salary ≤ ₹21,000
• Professional Tax (PT): Levied by some states, varies by salary slab
• Tax Deducted at Source (TDS): Based on total income and tax declarations

📉 We make sure all deductions are transparent in the payslip, which helps employees plan their finances better.

Here is a quick table summarising the above details 

Compliance requirements in India

Indian payroll compliance is detailed and involves central and state-level obligations. Here's a breakdown:

Labour laws

Organisations must follow several labour laws in India related to wages, working conditions, and benefits. Key laws include:

• Minimum Wages Act
• Payment of Wages Act
• Shops and Establishments Act (varies by state)
• The Code on Wages, 2019 (expected to replace some older laws)

🧾 I recommend scheduling regular reviews with legal or compliance teams to stay updated on local regulations, especially if you're operating in multiple states.

Social security contributions

Employers must contribute towards:

• Provident Fund (PF): 12% of basic salary, matching the employee’s contribution
• ESI: For eligible employees, covers health benefits
• Gratuity: Payable to employees who complete 5+ years of service (as per the Payment of Gratuity Act)

Tax liabilities

Companies are responsible for:

• Monthly deposit of TDS with the Income Tax Department
• Quarterly TDS returns in Form 24Q
• Annual issuance of Form 16 to employees for tax filing
• Calculating tax based on declarations, investment proofs, and exemptions

⚠️ Missing a deadline or making incorrect deductions can result in penalties or notices. We use automated payroll tools to manage filings and alerts.

The future of payroll in India

Payroll systems in India are becoming more digitised and integrated. Key trends include:

• Cloud-based payroll software with employee self-service portals
• Automated tax and compliance updates
• Integration with HR and accounting platforms
• Greater focus on employee experience, like faster reimbursements and real-time payslips

📲 In my view, automation is not just about efficiency - it builds transparency and trust in how payroll is managed.

Native Teams, your Indian payroll solution

If you're looking to hire or pay employees in India, Native Teams can help simplify payroll for you.

We offer:

• End-to-end payroll processing tailored to Indian regulations
• Support for both local entities and global companies via Employer of Record (EOR) services
• Automatic tax calculations and compliance updates
• Employee onboarding, documentation, and payslip management
• Secure payments directly to Indian bank accounts

✅ Whether you’re a startup or an established global brand, we help you stay compliant while focusing on your core business.

In summary

Payroll processing in India involves several moving parts. From pre-payroll prep to tax filings, every step matters. Hopefully, this guide helps you understand the ‘why’ and ‘how’ of it all.

If you’re doing it in-house, make sure every step is double-checked. Or better yet, let someone like Native Teams manage it end-to-end for peace of mind.