Understanding Indian income tax for employers
Reviewed by Mellow Editorial Team, HR & payroll content team
Employers in India are responsible for calculating, deducting and depositing income tax on behalf of their employees — this is called TDS on salary. Getting it wrong means penalties for the company, not just the individual.
What TDS on salary actually means
TDS stands for Tax Deducted at Source. When you pay salaries, you are required to estimate each employee's total taxable income for the financial year, calculate the tax due, and deduct it proportionally across the monthly payroll. The money goes to the government on the employee's behalf.
You do not wait until the employee files a return. The deduction happens every month, and you deposit it with the tax authorities by the due date. At year end, you issue Form 16 to each employee — a certificate showing total salary paid and total tax deducted. You also file Form 24Q, the quarterly TDS return, which captures the same information in a format the tax department uses for reconciliation.
How the new tax regime changes your calculation
From the 2026/27 tax year, the default regime for most employees is the new tax regime. It has a simpler slab structure that rises progressively to 30% at higher income levels, with fewer exemptions and deductions compared to the old regime.
The key practical point for employers: an employee can still opt for the old regime, but they must declare this to you in writing at the start of the financial year. Until you receive that declaration, assume the new regime applies. If an employee changes their choice mid-year, your calculation must be revised.
Under both regimes, a 4% health and education cess is added on top of the basic tax liability. The section 87A rebate reduces tax to nil for employees whose income falls below a certain threshold — check the current Finance Act for the precise figure, as this can change in each Budget.
Your obligations as an employer, month by month
At the start of the year, collect investment declarations from employees — proposed contributions to provident fund, insurance premiums, home loan interest, and so on. These affect the taxable income figure you use for TDS estimation.
Each month:
- Calculate gross salary
- Subtract exemptions and declared deductions that apply (more relevant under the old regime)
- Apply the appropriate tax slab to arrive at annual tax liability
- Divide by the remaining months in the financial year to get the monthly deduction
- Add cess, subtract any rebate applicable
Toward the end of the year, ask employees to submit proof of actual investments. If actual amounts differ from declarations — which they often do — you adjust the remaining monthly deductions to ensure the correct total is deducted by March.
Deposit the deducted TDS with the government by the 7th of the following month (or the date applicable to government employers, which differs). File Form 24Q for each quarter.
EPF and ESI: separate from income tax, but part of the same payroll run
Income tax is not the only statutory deduction. Provident Fund contributions run alongside it: 12% of basic salary is deducted from the employee's pay, and you contribute a matching 12% as the employer. These go to the EPFO and are separate from your TDS deposit.
ESI applies to employees whose wages fall below the relevant threshold. The contribution rates are split between employer and employee. Like EPF, this is deposited separately and is not part of the income tax process.
Running these in parallel means payroll involves multiple deductions, multiple deposit deadlines and multiple filings. Mixing them up or missing one affects compliance across different departments — income tax authority, EPFO and ESIC.
What changes under the Labour Codes
India's four consolidated Labour Codes came into force in 2025. They affect how "wages" are defined, which has a downstream effect on the base used for EPF and gratuity calculations. Employers need to confirm that their definition of basic salary and allowances aligns with the new definition of wages — because if basic pay is understated, EPF contributions may be too low, and that is a compliance risk.
Gratuity remains payable after five years of continuous service. The Labour Codes do not change this entitlement, but they do consolidate the rules under a unified framework.
Form 16, reconciliation and the employee's return
Every employee you deduct TDS for is entitled to Form 16 by 15 June following the close of the financial year. This document is their primary proof of income and tax deducted when they file their own return.
If your Form 24Q figures and the employee's Form 26AS (their tax credit statement, auto-populated by the tax department) do not match, the employee gets a mismatch notice. That notice reflects on your filing quality. Accurate monthly deposits and correct PAN details for every employee are the most direct way to avoid this.
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