Indian payroll explained for small businesses
Reviewed by Mellow Editorial Team, HR & payroll content team
Running payroll in India means calculating employee net pay after deducting income tax (TDS), provident fund contributions and any applicable ESI, then filing the right returns with the government on time. For a small business, getting this right from day one protects you from penalties and keeps your team's trust.
What payroll in India actually involves
Payroll is not just transferring salaries. Each month you must calculate gross pay, apply statutory deductions, remit those deductions to the correct authorities, and keep records that satisfy tax and labour law. In 2026, India's four consolidated Labour Codes are also in force, which reorganises several older Acts — so your compliance obligations are now governed by this updated framework.
The core moving parts are:
- Income tax (TDS) deducted monthly from salary
- Provident Fund (EPF) contributions from both employer and employee
- ESI for eligible employees
- Payslips issued to employees
- Quarterly returns and annual forms filed with the income tax department
Income tax and TDS on salaries
You are responsible for deducting tax at source from every employee's salary each month. Under the new tax regime, income tax slabs rise up to 30%, with a section 87A rebate available for employees below a certain income level. A 4% health and education cess applies on top of the computed tax.
How to do this in practice: at the start of the financial year, collect each employee's investment declarations and chosen tax regime. Use those to estimate their annual tax liability, divide by twelve, and deduct that amount each month. Adjust in the final months if their actual figures differ from declarations.
At year end:
- Issue Form 16 to every employee — this is their certificate of TDS deducted and deposited on their behalf
- File Form 24Q quarterly with the income tax department — this reports the TDS you have deducted across your payroll
Missing a Form 24Q deadline or depositing TDS late attracts interest and penalties, so calendar these dates firmly.
Provident Fund: what you owe as an employer
EPF applies to establishments above a certain size, though many small businesses register voluntarily or are required to once they cross the threshold. The contribution rate is 12% of basic wages from the employee and a matching 12% from you as the employer.
The employer's 12% is actually split between EPF and the Employees' Pension Scheme — the exact allocation is set by the EPFO. You remit the combined total (employee share plus employer share) to the EPFO by the due date each month.
Each employee gets a UAN (Universal Account Number). You link new employees' UANs on the EPFO portal when they join and file monthly ECR (Electronic Challan cum Return) filings. Keep these filings current — employees check their PF balance and rely on your deposits being on time.
ESI: covering lower-wage employees
The Employees' State Insurance scheme covers employees whose wages fall below the applicable threshold. Both employer and employee contribute a percentage of wages. If your employees earn above that threshold, ESI does not apply to them, but you need to check individually — not by blanket assumption.
Registration with ESIC is required once you have the requisite number of employees. Contributions are due monthly and filed through the ESIC portal. ESI provides employees with medical and other benefits, so non-compliance has direct consequences for your team, not just for you.
Gratuity: the long-term liability to plan for
Gratuity is not a monthly deduction, but it is a statutory liability that small businesses often underestimate. An employee who completes five years of continuous service becomes entitled to gratuity on leaving. The amount is calculated on the basis of their last drawn salary and the number of years served.
This means every employee you retain past five years creates a gratuity obligation. Prudent businesses provision for this gradually — either through a gratuity trust or an LIC group gratuity scheme — rather than meeting the lump sum from cash flow at the moment of exit.
Building a compliant payroll process
For a small business, the practical sequence each month looks like this:
1. Finalise attendance and variable pay components
2. Calculate gross pay for each employee
3. Apply TDS, EPF (employee share) and ESI deductions
4. Transfer net pay to employee bank accounts
5. Remit TDS to the government, EPF contributions to EPFO, and ESI contributions to ESIC — each by their respective due dates
6. Update payroll records and issue payslips
Annual tasks include issuing Form 16, filing Form 24Q for the full year, and reconciling your PF and ESI accounts.
Many small businesses start on spreadsheets, which works at very small scale but becomes error-prone once you have more than a handful of employees or if any staff are on variable pay. The compliance calendar alone — TDS deposits, quarterly 24Q filings, monthly ECR, ESIC returns — creates enough recurring work that a dedicated payroll tool or a payroll service usually pays for itself in saved time and avoided penalties.
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