Indian Payroll System: The Ultimate Guide in 2023

Are you planning to expand your team in India to hire the top tech talent?

Each of the 28+ states in India has unique laws and regulations for payroll. It is daunting to navigate through these while hiring in India. If you plan to do it all by yourself, it can put you at risk of non-compliance. 

The Indian payroll system is a diverse landscape with complex regulations and state-specific requirements regarding wages, overtime and employee benefits. Tax rates are revised annually with every budget, making tax filing a complex process for larger firms. 

Moreover, companies must comply with a plethora of legal regulations and worker laws as non-adherence can result in hefty penalties. Alongside these challenges, integrating with local banking systems for fund transfers can pose technical hurdles.

How can companies manage payroll seamlessly in India while expanding their teams? 

We will give you an overview of the Indian payroll system and how Rapid helps global companies to hire tech talent from India without any hassles.

We will cover:

       What is the Indian payroll system?

       payroll process in India

• Step 1: Establishing a legal presence
• Step 2: Set up payroll system and processes
• Step 3: Implement statutory compliance
• Step 4: Establish employee benefits
• Step 5: Draft employment contracts
• Step 6: Employee onboarding
• Step 7: Manage taxation and social security
• Step 8: Ensure data privacy and security
• Final Step: Get expert guidance and local support

What is the Indian Payroll System?

The Indian payroll system revolves around effectively managing employee salaries and benefits and guaranteeing adherence to statutory obligations. 

The salary structure consists of four elements that determine an employee's compensation. 

1. Basic salary, which forms the foundation
2. Allowances like HRA, DA, child care allowance and special allowance
3. Perquisites such as food, transport and rent
4. Retirement funds like the gratuity fund and pension fund, which contribute to employees' long-term financial security

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With respect to compliance, there are a few things to keep in mind:

You have to take care of Provident Fund (PF) contributions, where both the employer and the employee chip in a percentage of the employee's basic salary plus dearness allowance. 

Then there's the Employee State Insurance (ESI) scheme, which provides health insurance benefits. It applies to certain establishments and both parties contribute to the ESI fund.

You also need to consider other statutory requirements like bonuses, gratuity payments, professional tax (PT) and tax deducted at source (TDS). 

Bonuses are based on specific criteria set by the Payment of Bonus Act, whereas gratuity is a retirement benefit for employees with at least five years of service. 

Professional tax varies from state to state and the employer deducts it. 

TDS, on the other hand, is deducted from employee salaries if their income exceeds the taxable limit. 

Payroll Process in India

The Indian payroll system can be quite intricate, but with the right knowledge and guidance, you can navigate it smoothly. If you decide to hire talent in India, this is what the process of payroll looks like: 

Step 1: Establishing a Legal Presence  

The first step is to determine the appropriate legal entity structure for your operations in India, such as setting up a subsidiary, branch office, liaison office or representative office. Each structure has its own advantages and considerations with respect to ownership requirements, tax implications and operational flexibility. Consult with legal and tax experts to make an informed decision based on your specific business requirements.

Once the legal entity structure is determined, you must register with the Registrar of Companies (ROC) and the relevant tax authorities. It involves submitting the necessary documents, such as the company's memorandum and articles of association, details of directors and registered office address. 

Simultaneously, you must: 

• Apply for a unique identification number (PAN) from the Income Tax Department for tax-related purposes.
• Register for the Goods and Services Tax (GST) if your business activities require it.
• Obtain an Employer Identification Number (EPF) and register with the Employees' State Insurance Corporation (ESIC) for social security compliance.
• Obtain any required licences or permits related to employment and business operations, such as professional tax registration, trade licence etc.

Establishing a legal entity in India can be a complex and time-consuming process, especially if your company is looking to quickly access the Indian talent market. 

Alternative to Setting Up Your Own Legal Entity

What if you could seamlessly hire in India without the need to set up a legal entity or handle any legal complexities?

Rapid is an EOR platform that has deep local expertise in India. 

• You can streamline the payroll process while focusing on core business operations efficiently. 
• You can bypass the complexities of establishing a legal entity in India, saving valuable time and resources. It takes care of all legal and compliance aspects, ensuring that your payroll operations align with Indian laws and regulations. 
• You get access to an integrated services marketplace to streamline operations, enabling you to hire professionals and offer a seamless end-to-end experience.

However, if you are inclined to explore the option of managing your payroll independently, we understand the need for flexibility. 

Let us take a look at the Indian payroll process for those who wish to take the DIY approach. 

Step 2: Set Up Payroll System and Processes 

Compliance with Indian payroll requirements involves developing processes for salary calculation, tax withholding and employee benefits administration that adhere to applicable laws and regulations. 

Follow these steps to set up your payroll process in India::

• Define Salary Components and Structure- Determine the salary components and structure for your employees, considering elements such as basic pay, allowances (e.g., HRA, DA, special allowance), deductions and statutory contributions (e.g., PF, ESI).

• Establish Payroll Policies and Processes- Develop clear policies and processes for salary calculation to accurately calculate the net salaries of employees, which involves factors like attendance, leaves, overtime and other applicable variables. Additionally, define the process for tax withholding and employee benefits policies. 

• Implement Payroll Software or System- Choose and implement a suitable payroll software or system that can efficiently handle payroll calculations, tax deductions, statutory compliance and generate the necessary reports. Ensure the software is compatible with Indian payroll requirements.

• Set Up Statutory Compliance Systems- Establish systems to manage statutory compliance obligations, such as PF contributions, ESI registration, PT deductions and other requirements specific to your location or industry.

Step 3: Implement Statutory Compliance

The key aspects to consider when implementing statutory compliance are:

1. Compliance with Labor Laws: To maintain a compliant workforce, familiarise yourself with key labour laws such as the Industrial Disputes Act, Factories Act, Shops and Establishments Act and Minimum Wages Act. These laws govern aspects like working hours, overtime, leave entitlements, employee termination and workplace safety.

2. EPF, ESI and PT: Compliance with EPF, ESI and PT requirements includes deducting and contributing the employee's share to EPF and ESI, filing regular returns and maintaining accurate records. 

3. TDS: Comply with TDS provisions by deducting income tax from employees' salaries based on the prevailing tax slab rates. Obtain a Tax Deduction and Collection Account Number (TAN) and deposit the TDS with the Income Tax Department within the specified timelines. Issue Form 16 to employees, providing details of TDS deducted and deposited.

4. Employment Exchange Registration and Equal Employment Opportunity: In certain states like Tamil Nadu, Maharashtra and Karnataka, employers may need to register with the local employment exchange and provide periodic reports on employment statistics and job vacancies. Ensure compliance with anti-discrimination laws and promote equal employment opportunities for all candidates, avoiding discrimination based on protected characteristics.

5. Employee Eligibility Verification: Conduct background checks and verify documents such as identity proof, address proof and educational qualifications to ensure employee eligibility and credibility. Rapid provides background check services to thoroughly screen job candidates and examine their criminal records, employment history, education and other pertinent information. It offers three tiers of background checks and detailed reports in partnership with SpringVerify..

6. Reporting and Filing Requirements: This includes filing periodic returns, maintaining records of professional tax payments and providing necessary reports on employment and job vacancies.

By meticulously implementing statutory compliance, you can ensure legal adherence, mitigate risks and create a compliant and efficient workforce in India. 

The Indian payroll system encompasses distinct laws and regulations for various employee categories, including permanent employees, contract workers and consultants. Let's examine the differences:

Step 4: Establish Employee Benefits

By establishing employee benefits, you can create a favourable work environment and attract top talent. In India, it involves understanding both mandatory and additional benefits that can enhance the overall employee experience.

Mandatory Employee Benefits

Mandatory employee benefits in India include gratuity, maternity benefits and social security schemes. 

• Gratuity is a retirement benefit provided to employees who have completed a minimum of five years of service. 
• Maternity benefits are granted to female employees, ensuring their well-being during pregnancy and childbirth. 
• Social security schemes, such as the EPF and ESI, provide financial security and healthcare coverage to employees.

Additional Benefits

In addition to mandatory benefits, offering attractive supplementary benefits can help attract and retain talented individuals. 

• Health insurance plans play a significant role in providing comprehensive medical coverage for employees and their families. Rapid provides best-in-class, curated and convenient options for employers to choose from three different health insurance packages to suit their needs, in partnership with Plum. 
• Retirement plans, such as the National Pension System (NPS) or employer-sponsored pension schemes, ensure financial security for employees after their working years. 
• Employee assistance programs, including counselling services and work-life balance initiatives, promote the overall well-being of employees.

Step 5: Draft Employment Contracts

When drafting employment contracts, companies must create comprehensive agreements that outline all the essential terms and conditions of employment and provide clarity and protection for both the employer and the employee. 

Keep the following in mind while drafting your employment contract:

• Include key details such as the job title, compensation structure and benefits package, which ensures that both parties are clear on the agreed-upon salary, bonuses, allowances and any other financial arrangements. 

• Ensure that the employment contracts comply with the minimum statutory requirements mandated by Indian labour laws, which includes specifying notice periods, probation periods and confidentiality clauses as required by law.

• Additionally, if required, include terms to protect intellectual property rights, enforce non-compete agreements or establish post-employment restrictions. By explicitly addressing these matters in the contract, you can mitigate risks and safeguard your intellectual assets.

Drafting employment contracts necessitates meticulous attention to detail, expertise in labour laws and a deep comprehension of employer and employee needs. However, Rapid facilitates this process by generating locally compliant contracts swiftly and efficiently. It streamlines the process, saving employers time and effort while ensuring comprehensive contract content.

Step 6: Employee Onboarding

To facilitate a seamless transition and successful integration of new employees into the organisation, effective employee onboarding should encompass the following essential elements:

• Provide orientation sessions to familiarise employees with the company's culture, values and policies, which help create a positive work environment and set clear expectations.

• Collect and verify necessary employee documentation, including identity proof, address proof and bank account details. These documents are essential for legal and administrative purposes.

Rapid offers a convenient digital onboarding process for employees, reducing the onboarding time from 6-8 months to 5 minutes. Our eKYC (electronic Know Your Customer) feature enables employees to provide all the necessary information and documentation online. It eliminates the need for cumbersome paper-based processes and saves time for employees and the organisation. 

The user-friendly digital onboarding process can be completed from anywhere, making it easy for employees to start their new roles swiftly and efficiently!

Step 7: Manage Taxation and Social Security

Businesses must navigate various requirements to comply with Indian tax regulations and ensure proper social security coverage for employees. Here's an overview of how to effectively manage taxation and social security in India:

1. Income Tax Compliance: Indian income tax regulations govern the taxation of employee salaries. It includes tax withholding, where employers deduct taxes from employee salaries based on applicable tax slabs. Compliance entails accurately calculating and withholding taxes, remitting them to the tax authorities and providing employees with Form 16, a salary certificate detailing their income and tax deductions.

2. Social Security Compliance: In India, two significant social security schemes are EPF and ESI. Employers are required to register and contribute to these schemes for eligible employees. EPF contributions help build retirement savings, while ESI provides health insurance and medical benefits. It requires timely contributions, accurate calculations and ensuring necessary filings and documentation.

3. Payroll Tax Compliance: Alongside income tax, businesses must adhere to other payroll tax obligations. It includes deducting taxes such as PT from employee salaries, remitting them to the appropriate authorities and ensuring compliance with Goods and Services Tax (GST) regulations for applicable transactions.

Indian tax laws, rates, slabs and allowances can undergo periodic changes. So, you must stay updated with these changes to ensure accurate tax calculations, withholdings and filings. 

Rapid helps with tax management and also practises passthrough taxation, wherein the GST benefits for non-salary payments, such as office space rentals and equipment purchases, are passed on to the client.

Step 8: Ensure Data Privacy and Security

Companies can safeguard employee data and comply with data protection laws with the following measures:

• Establish comprehensive policies and procedures to protect employee data and comply with data protection laws that outline how employee data is collected, stored, processed and shared.

• Familiarise yourself with the data protection framework in India, including the Personal Data Protection Bill and ensure your data handling practices align with the regulations.

• Establish protocols that adhere to cross-border data transfer regulations and implement measures such as encryption, access controls, backups and secure storage practices.

By prioritising data privacy and security, businesses can build trust, protect sensitive information and mitigate the risks associated with data breaches and non-compliance with data protection laws in India.

Rapid prioritises data privacy and security. All activities related to contractors, employees and other HR processes, including payments, are conducted through our platform, ensuring a streamlined and efficient process for employers and employees/contractors alike. By having all necessary information and data available in one secure place, our platform provides a transparent system for managing all HR-related transactions.

With Rapid, you can have peace of mind knowing that your data is protected and handled with the utmost care!

Step 9: Get Expert Guidance and Local Support

The Indian payroll landscape is complex, with various laws and regulations varying across states. It can make compliance a challenging process. However, by partnering with an employer of record (EOR) like Rapid, you can alleviate the burden of managing these complexities.

Rapid offers comprehensive EOR services, providing expert guidance to ensure compliance with the ever-changing Indian employment laws. With a team of local experts, it streamlines the entire employee lifecycle, from onboarding to payroll processing, ensuring adherence to local regulations and peace of mind for companies expanding their teams in India.

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By partnering with Rapid, you can benefit from our local expertise, minimising compliance risks and ensuring a seamless payroll experience in India! 

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