Guide to statutory compliance in payroll for India

Apr 05, 2024

The payroll function is possibly the most critical business operation for any company. It is the only function that can directly impact the standard of living for all its employees.

Payroll is also essential for companies since they are legally obligated under the rules and regulations set by the government of India to provide accurate compensation and adhere to taxation laws.

Statutory and payroll compliance in India is an evolving set of regulations and therefore requires an effective payroll process to avoid penalties. Our statutory and payroll compliance guide is everything you need to know to be up to date with labor laws.

What is payroll?

Payroll refers to the money paid by the company to its employees in exchange for services rendered. As one of the key business operations and expenses, payroll is more than disbursing salaries and wages.

It consists of formulating payroll policies around benefits like leave encashment policy, defining the fixed and variable structure in the payslip, calculating net payout of gross salary, and tax deduction at source, depositing Provident Fund, etc.

What are different payroll functions?

1. Structuring compensation

The payroll function begins with creating a detailed employee compensation structure, which includes components such as salary, overtime, and more.

2. Paycheck processing

Payroll is primarily responsible for processing paychecks and applying deductions wherever necessary and applicable.

3. Managing taxes and filing returns

One of the major payroll functions is to ensure timely and accurate payment of taxes. Failure to do so can result in steep fines and even jail time. It is an important component of payroll compliance.

4. Payroll reports and salary slips

Payroll management generates salary statements and payroll reports to reflect the business's taxes, budgets, and other liabilities.

5. Enforcing statutory compliance in payroll

Payroll compliance in India adheres to many state and federal laws. Due to this, it is extremely crucial for the business to follow the rules laid down by the government. 

What does compliance mean in payroll for businesses?

Statutory compliance in payroll refer to the certain set of rules and regulations formulated by the government on a state and federal level that must be adhered to by businesses.

Payroll and statutory compliance in India constitutes all the labor and taxation laws. To ensure effective implementation of statutory compliance, the payroll and statutory compliance function of your business must stay up to date with the labor laws in India.

Statutory compliance for payroll in India

Effective payroll compliance in India stems from the variety of labor laws introduced by the Ministry of Labour and Employment, Government of India.

1. Statutory for social security

Employee state insurance act

ESI act is established to help employees avoid unpredictable circumstances such as maternity leave, medical or accidental emergencies, disability in the workplace, and more.

Under Employee State Insurance Act, the employer contributes 3.25% of each paycheck, while the employee contributes 0.75%.

ESI act is a mandatory law for non-seasonal factory owners where more than 10 employees are working, earning less than ₹21000 per month.

Since it is applicable only to employees earning less than INR 21000, it is important for the HR payroll function to ensure that the employee has not gone beyond that limit through appraisals or promotions.

If the employee starts earning more than the limit, the ESI contribution shall last till the end of the semi-annual cycle, from April to September or October to March.

Employee provident fund act

EPF is one of the largest welfare contribution funds for employees. Under the Employee Provident Fund Act, both the employer and employee are subjected to contribute up to 12% of their basic pay and dearness allowance (DA) towards the EPF.

Employee contribution towards the provident fund is exempted from taxation under section 80C of the Indian Income Tax Act. Companies having more than 20 employees must comply with the EPF act.

According to the statutory and payroll compliance in India, failure to adhere to the Employee Provident Fund act can land employees in serious trouble, such as expensive fines, rescinded licenses, and even imprisonment.

Labour welfare fund act

The Labour Welfare Fund is formulated to assist employees working in a specific set of industries. The fund provides employees with the necessary resources to improve their standard of living whilst maintaining better working conditions in the workplace.

The welfare fund is governed by the state in which a particular company is established. The contribution amount to this fund can vary from state to state and can occur on an annual or semi-annual basis.

It is also important to know that some states do not offer a labor welfare fund. These include a majority of the North Eastern states and union territories, other states such as Bihar, Rajasthan, Uttar Pradesh, Himachal Pradesh, and more.

It is advisable for your age department to keep itself up to date with the labor welfare fund information.

Payment of gratuity act

Gratuity is yet another important factor in employee welfare. Gratuity paid with Employment Provident Fund establishes one of the most essential statutory compliance in payroll for businesses.

Gratuity is defined as an amount paid to the employee by the employer for the services provided during their tenure with the company.

However, there is a condition: an employee is eligible for payment of gratuity only if they have served a minimum of 5 years in their respective workplace.

Since there is no fixed amount or percentage of gratuity offered to an employee, employers can calculate gratuity on the basis of an employee's salary and the years of service rendered to the business.

The employees in an organization can further be segregated into two categories: those that are covered under the act and those that are not.

2. Statutory employee wages

Payment of wages act

This Act safeguards employees belonging to diverse industries by ensuring that they are paid in a timely manner, with severe penalties being imposed on defaulting employers.

Under the Payment of Wages Act, employees are legally bound to pay employees before the 7th of every month in companies having less than 1000 employees.

They can pay employees before the 10th of every month where company strength exceeds 1000 employees. This law protects only those employees who earn salaries of less than ₹10000 rupees every month.

The preferred mode of payment can be either cash or cheque, with bank transfers being another mode only if an employee consents to it. Payment of Wages Act adheres to state legislation and can vary from one state to another.

Minimum wages act

The Minimum Wages Act protects the labor class from exploitation by setting the minimum wage rate employers must provide.

While the Minimum Wages Act comes under central legislation, the minimum wage set can differ from state to state, or industry to industry, owing to the vast differences in the standard of living across India.

Many parameters are considered to evaluate and decide the fixed minimum wages in a state and industry.

These parameters include the population density of a certain geographic area (urban or rural), cost of living expenses, type of employment, wage period, and more.

Payment of bonus act

The Payment of Bonus Act is founded on the solitary purpose of providing cash incentives to employees across factories and companies with an employee count of more than 20.

Under this act, employees receive a bonus compensation based on their salary and the profits earned by the company within a financial year.

Employees earning ₹21000 or less having served at least 30 days are eligible to claim the bonus from their employees.

Payment of Bonus Act serves as a bridge between the employer and the employee to share in the growth and prosperity of the company.

By incentivizing employees, the Payment of Bonus Act maintains a harmonious level between labor and capital.

Maternity benefits act

The Maternity Benefit Act is a step taken by the Indian government to provide equality to women in the workforce full stop under this act, women are legally protected to take full paid maternity leave from the workforce without being subjected to discrimination.

Maternity Benefit Act is one of the most fundamental statutory and payroll compliance regulations in India that companies having more than 10 employees must follow under any circumstance.

To be eligible for the benefit, the female employee has to have worked in the organization for a minimum of 80 days in the past year.

This act is ubiquitous to a wide number of organizations such as factories, government, and nongovernment establishments, mines, and any other workplace that comes under the central government of India.

Maternity leaves can be applied for up to 26 weeks and are also applicable to two women working from home in our current corporate setup.

3. Tax liabilities, and benefits

TDS (Tax deducted at source)

A crucial component of statutory and payroll compliance regulations, Tax deducted at source is established to collect tax from an employee's income. TDS is levied on a variety of income types such as salaries interest and more.

TDS is charged with respect to an individual salary. For efficient payroll compliance in India, the government has introduced two types of regimes that an employee can choose from.

Under the old tax regime, employees were subjected to 120 possible exemptions. However, the new tax regime has eliminated 70 of those exemptions, with only 50 available for a tax deduction. 

Risk of non-compliance for the company

With the ever-changing landscape of government rules and regulations, conducting smooth business operations is not as easier as it once was.

To attain a better grasp of legally mandated regulations, statutory compliance in payroll can help businesses streamline processes from Day 1. Failure to comply with statutory regulations in India can land businesses in a legal quagmire.

Companies that do not adhere to payroll compliance in India can face heavy penalties, and fines, and may even risk shutting down their operations entirely.

Not only does non-compliance amount to civil or criminal liabilities, but it can also severely impact the company's goodwill and reputation in the marketplace.

Interesting read: Key major trends driving the fintech revolution in India

How is payroll calculated in India?

Payroll processes how companies determine the next payment, which is the amount that the company owes to the employees in exchange for the services rendered.

To calculate net pay, two important components are gross income and gross deduction. Gross income or gross salary is the sum total of all kinds of regular income that the employee receives.

It also includes allowances such as house rent allowance, and transport allowance, along with any one-time payment or benefit such as sign-on bonus or relocation bonus.

Gross deductions refer to all types of regular deductions including statutory deductions such as provident funds, employee welfare funds, as well as any one-time deduction.

To calculate net pay, simply subtract gross deduction from an employee's gross income.

Understanding the components of salary structure in India

1. CTC (Cost to company)

Cost to the company, also known as CTC, is the total amount that an organization spends on an employee.

It encompasses the entire salary package and monthly components such as the base salary, allowances, and one-time bonuses. CTC should not be confused with the take-home salary amount.

2. Gross salary

Identical to gross income, gross salary is the sum total of an employee's base pay, allowances, bonuses, overtime payments, and more. Gross salary is calculated before tax and any other deductions.

3. Net pay take-home salary

The take-home salary is the amount that the employee receives in hand in exchange for their services to the company. The take-home salary is calculated after deducting TDS, provident fund, professional tax, and other such deductions from the gross salary.

4. Allowances

Allowances are a kind of mandatory benefit extended to the employee beyond their basic salary. These allowances can be either partially or fully taxable, or eligible for tax exemption. Commonly provided allowances are

House rent allowance

HRA is offered by companies to their employees in order to assist them in renting living spaces. The house rent allowance is usually 50% of the base salary for employees residing in metropolitan areas and 40% for those in non-metropolitan areas. 

Medical allowance

The company is responsible for its employees’ physical well-being and therefore provides a fixed amount of medical allowance for any medical-related expenditures.

Leave travel allowance 

Leave travel allowance is offered by businesses to cover their employees' travel expenses outside of work-related travel. This allowance is eligible for tax exemption.

Conveyance allowance

Conveyance is provided to employees to meet their travel expenses to and from the workplace to their homes.

5. Deductions

When gross deductions are subtracted from the gross salary or the CTC, the amount left is the actual take-home salary for the employee. Some common deductions are.

Provident fund

As mentioned earlier, Employee Provident Fund is a welfare contribution for employees, wherein a set amount is deducted from both the employer and employee each month.

Employees state insurance

ESI is an amount paid by the company to an employee with a gross salary of less than 21000 for a month. If a company has 10 or more employees, the amount is paid in full during a genuine medical leave.

Professional tax

Professional tax is a nominal amount levied by the government on all salaried employees.

Labour welfare fund

Labour welfare fund is a state-managed contribution provided to employees in order to improve their standard of living.

National pension scheme

An initiative by the government of India, the national pension scheme allows employees to create a fund accessible post-retirement.

Stages of a company’s payroll cycle

Pre payroll activities

1. Creating a payroll policy

The earliest and perhaps the most crucial component of the entire payroll cycle is creating a set of policies in place to optimize payroll processing.

A payroll policy dictates in detail the steps the HR function needs to take before, during, and after payroll processing. The entire payroll policy is made up of a set of policies for specific processes such as the pay policy, leave policy, attendance policy, and more.

The specific policies help the company to streamline the payroll processes and show that the employees receive accurate payments in a timely manner.

2. Preparing payroll data

Once the policy is formulated and approved by the management, the next step is to prepare payroll data. This data is sourced from all departments within a company to maintain accuracy in the payroll process.

Data provided by employees around their investment declarations is an essential part of the payroll data. Similarly, the salary and benefits structure and advances availed are sourced from the HR and Finance departments.

Finally, systems set to monitor leave and attendance provides important information regarding employees' working days to further optimize their payroll process.

3. Approval and verification of payroll data

Not all the data provided is foolproof. Ensuring data accuracy in payroll processing is essential to offset grievances or complaints raised by employees regarding incorrect salaries.

In order to do this, the raw data must be reconciled with the company policy to eliminate any double inputs and oversight.

Ensure that the payroll process does not mention any inactive employees to avoid major complications.

Actual payroll process

Once the data is received and validated, the payroll calculation process begins. This is a vital part of the entire payroll process since it determines employees' actual take-home salary.

All the data collected regarding various gross salary components, incentives, reimbursements, expenses and deductions, and payroll for each employee is diligently calculated.

Adjusting deductions from gross salary will reveal the net pay an employee will receive at the end of the payroll process. It is wise to double-check your data in order to maintain authenticity and accuracy throughout.

Post payroll activities

1. Statutory compliance

Statutory compliance is an essential part of overall payroll compliance. The payroll supervisor must adhere to statutory compliance in payroll since failure to do so can land the company in legal trouble.

During payroll processing, statutory deductions such as provident fund, TDS, ESI, and labor welfare fund ( if applicable) are withdrawn. The company is legally obligated to pay these deductions to the relevant authorities and evade non-compliance.

2. Payroll accounting

Payroll accounting is a reliable process to obtain a clear view of the total cost of your employees incurred on the company. By diligently tracking payroll-related business expenses companies also get to keep a track of their overall payroll compliance.

In India, since statutory compliance in payroll is governed by local state and federal employment laws, it is prudent to manage an extensive database ensuring that the organization is not in violation of any regulations. 

3. Payout the salaries

Once statutory compliance and payroll accounting are completed, the payroll team can now begin disbursing salaries to the employees.

Companies can pay their employees either through cash, check, or bank transfers to employees' bank accounts. To ensure smooth payouts, it is ideal to have dedicated salary accounts for each of your employees.

This way companies can simply send the payroll statements along with employee identification and account numbers to their preferred bank branch, which can then take the process forward on their own.

It is prudent to create a detailed report comprising payroll and department information for each of the employees to assist the finance department in their reporting processes.

What are the ways to manage payroll for your company?

The payroll cycle is an extensive process that exists before, during, and after processing payroll to employees. This detailed journey consists of three distinct stages

1. Manual processing

Manual payroll processing refers to using spreadsheets for payroll management. Companies with fewer employees and working capital prefer manual payroll processing.

HR professionals use the standard calculation template to do basic payroll calculations for the company. While this method might appear cost-effective at the outset, traditional payroll systems like spreadsheets have a lot of disadvantages .

Legacy payroll spreadsheets are usually found to be riddled with calculation errors and typing mistakes since the work is done manually and is therefore highly prone to human error.

On top of that, managing employee lists can be a real headache on spreadsheets since it can easily ruin the format, forcing HR Teams to manually fix the issues.

Being error-prone, the chances of duplication and omission of data rises multifold, threatening your entire payroll process.

Spreadsheets also fail to automatically adjust themselves to the ever-changing statutory compliance regulations, especially in the case of wage codes, provident funds, and more.

2. Third party outsourcing

Using a third-party payroll agency to manage your payroll is known as outsourcing. Small to medium businesses often lack the dedicated payroll team required to manage the payroll function internally.

Under payroll outsourcing, companies have to provide these third-party agencies with their employees' information regarding salaries, reimbursements, leaves, benefits, deductions, and so on.

The agency then proceeds with payroll processing activities such as maintaining employee records, calculating net pay, distributing payroll, and creating payroll reports for the company.

Outsourcing payroll function has its own pros and cons. Payroll outsourcing definitely beats manual payroll processing and saves the company time and money. Agencies can uncover areas of hidden costs and bottlenecks in the payroll process.

In terms of statutory compliance in payroll, outsourcing is definitely better since third-party professionals are well versed with the labor codes and payroll and statutory compliance in India.

On the other hand, outsourcing payroll can result in a lack of control over the company's payroll operations. Payroll data is highly sensitive and sharing these with a third party may create confidentiality and data protection issues.

3. Payroll management software

Payroll management software goes beyond the basic salary calculation and streamlines pre-payroll and post-payroll activities for payroll and statutory compliance.

Such as Managing enrollment, exit records of employees, optimizing process workflows, integrating attendance and leave data, automatically adhering to the present payroll and statutory compliance codes in India, and much more.

Payroll management software helps companies save time on repetitive tasks and reduces their monetary investment in human resources.

Most payroll management software in the market today covers a wide range of payroll operations another one-stop shop for payroll calculation, leave and attendance management, and an employee self-service portal.

Switching to payroll management software can be particularly beneficial for companies' reliance on legacy payroll management systems.

Moving from paper-based to digital payroll processing and cloud-based processing can prove to be more beneficial.

Many software today work on a one-time annual subscription fee and are therefore more cost-effective than third-party payroll service providers.

Payroll software is much better than outsourcing for manual processing since it completely eliminates the chance of error in your payroll.

With an automated validation feature, payroll management software can quickly flag any wrong information entered into the system and avoid incorrect salary calculations.

Interesting read: Best AP automation software in India for 2023


Is the compliance process different for organisations?

Statutory and payroll compliance for a private limited company, LLP, or partnership firm are exactly the same. 

How are attendance and loss of pay calculated for payroll?

When an employee takes leaves after exhausting their paid leaves balance, then the employee will not be paid for excess leaves taken. This is known as loss of pay. Loss of pay is calculated on calendar day logic.

Are professional tax slabs different in different states?

Professional tax slabs vary from state to state. Professional tax in West Bengal, Maharashtra, Karnataka, and Kerala can vary from 0 to 200 depending on the employee's salary.

What is a professional tax in India?

Professional tax is a direct tax that is deducted from the employee's gross income by the employer. It is a state government levied tax and can vary depending on the state the company is established in. The highest threshold for the professional tax in India is 2500 and calculated on the basis of the salary slabs.

What are the EPF rules for employers?

Employers must make a minimum contribution of up to 12% of 15000, which equals 1805 monthly. Companies with more than 20 workers are legally obligated to contribute towards Employee Provident Fund.

What Is an Employee Provident Scheme (EPF) in India?

The employee provident fund scheme EPF is one of the largest welfare schemes offered by the government of India. PPF is completely exempt from taxation up to 2.5 lacs in a financial year, post which the interest earned on the contributions is liable to taxation. The employee provident fund protects employees against layoff, unemployment, retirement, and other unseen circumstances. Scroll up to read more about EPF inner for the payroll compliance guide.

Automate your payroll seamlessly with Volopay