Explained for First-Time Employers

Paying two co-founders can be managed over WhatsApp. The moment you hire your first employee, payroll becomes a statutory compliance function governed by multiple central and state laws. Most founders find out what they missed when a disgruntled ex-employee files an EPFO complaint, when a labour inspector visits, or when a statutory audit flags missing filings.

This guide covers the four core payroll compliance obligations every Indian employer must manage: Provident Fund, Employee State Insurance, Professional Tax, and TDS on salary.

Before the Payslip: Understanding the Salary Structure

Four numbers appear in every salary conversation. They are not the same number.

CTC (Cost to Company) is the total annual expenditure the company incurs for the employee, including all salary components and employer-side contributions.

Gross salary is what appears in the monthly payslip before any deductions. It includes basic salary, HRA, special allowance, and any reimbursements.

Take-home (net salary) is what hits the employee's bank account after all deductions: employee PF contribution, professional tax, and TDS on salary.

Employer cost is the actual monthly cash outflow, which includes gross salary payments plus the employer's statutory contributions.

A practical breakdown of a ₹15L CTC employee (metro city):

Component	Annual (₹)	Monthly (₹)
Basic Salary (40% of CTC)	6,00,000	50,000
HRA (50% of basic)	3,00,000	25,000
Special Allowance	3,42,360	28,530
Employer PF (12% of basic)	72,000	6,000
Gratuity provision (4.81% of basic)	28,860	2,405
Other benefits	56,780	4,732
Total CTC	15,00,000	1,25,000

Employee's monthly gross salary: ₹50,000 + ₹25,000 + ₹28,530 = ₹1,03,530

Employee deductions from gross salary:

Employee PF: 12% of basic = ₹6,000/month
Professional tax: ₹200/month (Maharashtra)
TDS: depends on investment declarations and applicable tax regime

Approximate take-home: ₹96,000-₹98,000/month

Employer's monthly cash outflow: ₹1,03,530 (gross) + ₹6,000 (employer PF) = ₹1,09,530

The gratuity provision of ₹2,405/month is an accruing balance sheet liability, not a monthly payment.

Provident Fund (PF)

The governing legislation is the Employees' Provident Fund and Miscellaneous Provisions Act, 1952.

Registration is mandatory for businesses with 20 or more employees. Once registered, you cannot de-register even if headcount drops below 20. Voluntary registration is possible for smaller businesses, but once registered, all rules apply.

All employees earning up to ₹15,000/month basic salary must be enrolled. Employees earning above ₹15,000 basic can choose to opt in (most do) but are not compelled to.

Contribution rates: the employee contributes 12% of basic salary and the employer contributes a matching 12%, of which 8.33% goes to EPS (Employees' Pension Scheme) and 3.67% goes to EPF. The EPS contribution is capped at ₹1,250/month per employee. For employees with basic above ₹15,000, the EPS contribution stays at the cap.

File the ECR (Electronic Challan cum Return) monthly via the EPFO unified portal. Payment is due by the 15th of the following month. Delay attracts damages of 5% per annum for delays up to 2 months, scaling up to 25% for delays above 6 months.

Employees accumulate a PF corpus for retirement (EPF component), receive pension on retirement or exit (EPS component), and get EDLI insurance cover. The employer contributes 0.5% of basic, capped, for a group life insurance cover of up to ₹7 lakh.

One practical note: if a business registers voluntarily before crossing 20 employees, the rule applies to all current and future employees from that point. Think carefully before registering early. It is a permanent obligation.

ESI (Employee State Insurance)

The governing legislation is the Employees' State Insurance Act, 1948.

ESI is mandatory for businesses with 10 or more employees in most states where any employee earns ₹21,000/month gross or less. Only employees at or below that threshold are covered. For a startup where most engineers earn above ₹21,000, ESI often applies only to support staff, drivers, or operations employees.

Contribution rates: the employer contributes 3.25% of gross wages and the employee contributes 0.75%.

Contributions run across two periods: April to September (Period 1) and October to March (Period 2). If an employee's salary crosses ₹21,000 during a contribution period, they remain covered until that period ends before becoming exempt.

File a monthly challan via the ESIC portal, due by the 15th of the following month. Late payment attracts interest at 12% per annum.

Covered employees and their dependents receive medical care through ESIC hospitals and dispensaries, sickness cash benefit (70% of wages for up to 91 days per year), maternity benefit, disability benefit, and dependents' benefit.

One important note: ESI hospitals vary significantly in quality by location. Many employees in tier-1 cities prefer private health insurance. ESI is mandatory where it applies, and private insurance does not substitute for it.

Professional Tax

Professional Tax is a state-level tax on professional income, deducted from employee salaries by the employer and deposited with the state authority. It does not apply in Delhi, Rajasthan, and a few other states. The maximum rate is ₹2,500/year per employee nationally.

State-wise rates for selected states:

Maharashtra: up to ₹2,500/year for employees earning above ₹10,000/month
Karnataka: ₹2,400/year for employees earning above ₹15,000/month
West Bengal: up to ₹2,500/year on a graduated slab
Tamil Nadu: up to ₹1,200/year on a slab basis

Employers must register separately for Professional Tax Employer Registration in each applicable state, deduct from employee salary monthly, and deposit with the state authority on a monthly or quarterly basis depending on state rules and headcount.

If you fail to deduct, the employer is liable for penalties, not the employee. Rates vary by state but are typically a percentage of the outstanding amount.

TDS on Salary (Section 192)

This is the income tax deduction employers must make from employee salaries each month.

At the start of the financial year (April), each employee submits a declaration covering their investment plans under Section 80C, any HRA exemption claim, home loan interest deduction, and choice of old or new tax regime. Based on this declaration, you estimate their annual tax liability and divide it by 12 to get a monthly TDS deduction.

The deduction is not fixed for the year. If an employee's circumstances change (they buy a home, change their regime choice, declare additional income), they submit an updated declaration and you recalculate TDS for the remaining months.

New Regime vs Old Regime

Employees choose their preferred regime each year. Under the old regime, multiple deductions and exemptions apply (80C, HRA, LTA, home loan interest). Under the new regime, tax rates are lower but most deductions are unavailable. If no choice is declared, the new regime applies by default from FY 2024-25.

Filing requirements: Form 24Q is the quarterly TDS return for salary, due July 31 (Q1), October 31 (Q2), January 31 (Q3), and May 31 (Q4). Form 16 is the annual TDS certificate issued to each employee, due June 15 of the following year. Employees can verify their TDS credits via Form 26AS.

Late filing attracts ₹200 per day under Section 234E for delay in filing Form 24Q, and interest at 1.5% per month under Section 201(1A) for delay in depositing TDS.

Gratuity: The Long-Term Liability Most Founders Ignore

The governing legislation is the Payment of Gratuity Act, 1972. It applies to all businesses with 10 or more employees. Gratuity is payable to employees on exit after completing 5 or more years of continuous service.

The calculation formula is: (Last drawn basic salary ÷ 26) × 15 × number of years of service.

For example, an employee with ₹50,000 basic and 7 years of service: (₹50,000 ÷ 26) × 15 × 7 = ₹2,01,923. The maximum gratuity payable is ₹20 lakh (revised from ₹10 lakh in 2018).

If you wait until an employee resigns to think about gratuity, you face a large unexpected cash outflow. The right approach is to accrue ₹(basic × 4.81%) monthly in the books as a gratuity provision. Over a typical 5-7 year tenure, this builds to approximately the amount payable.

For larger teams, a Group Gratuity Policy from LIC or a private insurer allows you to fund the liability progressively and receive tax deduction on the premium.

Building a Payroll Process That Doesn't Break

The monthly payroll cycle:

Collect attendance, leave, and variable pay data by the 25th-28th of each month
Calculate gross salary for each employee, accounting for LOP (Loss of Pay) for unpaid leaves
Apply statutory deductions: employee PF, ESI (if applicable), professional tax, TDS
Generate payslips and process net salary transfers by the last working day of the month
Deposit employer PF by the 15th of the following month
Deposit ESI by the 15th of the following month
Deposit professional tax by state-specified deadline
Deposit TDS by the 7th of the following month (April 30 for March)

Razorpay Payroll, Keka, Darwinbox, and GreytHR are widely used in Indian startups. Most integrate with EPFO and ESIC portals for automated challan submission and return filing. They also handle TDS calculations and Form 16 generation.

Maintain wage registers, muster rolls, and payslips for a minimum of 3 years. Labour inspectors under the Shops and Establishments Act can request these during a visit.

Common Mistakes

Missing ESI registration when crossing 10 employees. Registration must be done within 15 days of crossing the threshold.

Not filing Form 24Q quarterly. Many founders assume TDS deduction is sufficient and forget the quarterly filing. The ₹200/day penalty under Section 234E adds up quickly.

Structuring very high basic salary. Basic salary is the base for PF, ESI (where applicable), and gratuity calculations. A ₹15L CTC employee with ₹8L basic has significantly higher employer PF and gratuity obligations than one with ₹6L basic.

Not provisioning for gratuity. The liability exists from the first day of employment. By the time an employee's 5-year anniversary arrives, the accumulated provision should be close to the payable amount.

Telling employees their CTC without explaining take-home. When the first payslip shows a number significantly lower than expected, the damage to trust is immediate.

Key Takeaways

PF registration is mandatory at 20 employees. Once registered, it's permanent and applies to all employees.
ESI is mandatory at 10 employees for employees earning ₹21,000/month gross or less. Private health insurance does not substitute for ESI.
Professional tax is state-specific. Register in each state where you have employees and follow that state's filing schedule.
TDS on salary requires quarterly Form 24Q filing and annual Form 16 issuance. Late filing attracts ₹200/day penalty.
Gratuity is payable after 5 years of service. Provision for it monthly from the first hire to avoid cash flow surprises on exit.

Payroll Compliance for Indian Startups: PF, ESI, PT and TDS