Payroll Setup in India: TDS, PF, ESI & Professional Tax from Day One

Introduction: Why Payroll in India Is Unlike Anywhere Else

Payroll in India is not simply about calculating gross-to-net and depositing salaries. It is a compliance-intensive operation involving four separate statutory deduction systems, each with its own registration process, contribution rates, payment deadlines, and filing requirements. A single missed deadline or incorrect calculation can trigger penalties, interest charges, and — in serious cases — prosecution of the company's directors.

This article is part of our Complete Guide to Hiring Employees in India as a Foreign Company. Here we dive deep into the practical mechanics of setting up and running payroll from your first hire.

For foreign companies establishing operations in India — whether through a wholly-owned subsidiary, branch office, or liaison office — understanding these systems before your first hire is critical. Retroactive compliance is expensive and disruptive. This guide covers each component in detail: TDS (Tax Deducted at Source), EPF (Employees' Provident Fund), ESI (Employees' State Insurance), and Professional Tax.

TDS on Salary: Section 192 of the Income Tax Act

How TDS Works

Every employer in India — including foreign-owned entities — is required to deduct income tax at source from employee salaries under Section 192 of the Income Tax Act, 1961. The employer acts as a withholding agent, estimating each employee's annual taxable income, applying the applicable slab rates, and deducting a proportionate amount from each monthly salary payment.

The employer must obtain a TAN (Tax Deduction and Collection Account Number) before deducting TDS. TAN application is filed through Form 49B on the NSDL/Protean portal. Processing typically takes 7-10 days. Without a TAN, the company cannot legally deduct or deposit TDS.

Income Tax Slabs for FY 2026-27 (New Regime)

The new tax regime is the default for FY 2026-27 unless the employee specifically opts for the old regime. The applicable slab rates are:

A standard deduction of INR 75,000 is available under the new regime (INR 50,000 under the old regime). Health and Education Cess of 4% is levied on the total income tax (including surcharge, if applicable).

TDS Calculation Method

The employer projects the employee's full-year income based on the current salary structure, subtracts eligible exemptions and deductions (under the chosen regime), applies the applicable slab rates, adds the 4% cess, reduces any applicable rebate under Section 87A, and divides the net annual tax liability by the number of remaining months to arrive at the monthly TDS amount.

Employees must submit Form 12BB declaring their investments and deductions. If an employee does not submit a regime choice, the new regime applies by default. The employer must issue Form 16 (TDS certificate) to each employee by 15 June following the financial year.

TDS Deposit Deadlines

TDS deducted from salaries must be deposited with the government by the 7th of the following month. For example, TDS deducted from March 2026 salaries must be deposited by 7 April 2026. For the month of March (last month of the financial year), the deadline is 30 April. Late deposit attracts interest at 1.5% per month from the date of deduction to the date of deposit, plus a late filing fee under Section 234E of INR 200 per day (capped at the TDS amount).

TDS returns must be filed quarterly using Form 24Q on the TRACES portal. The deadlines are 31 July (Q1), 31 October (Q2), 31 January (Q3), and 31 May (Q4).

Employees' Provident Fund (EPF): Registration and Contributions

When EPF Registration Is Mandatory

EPF registration with the Employees' Provident Fund Organisation (EPFO) is mandatory for any establishment employing 20 or more persons. Registration must be completed within one month of crossing the 20-employee threshold. However, establishments with fewer than 20 employees can also voluntarily register, and many foreign companies do so to remain competitive in attracting talent.

Registration is done online through the EPFO's Unified Portal (unifiedportal-emp.epfindia.gov.in). The employer needs the company's PAN, Certificate of Incorporation, registered office address proof, bank account details, and details of all employees including Aadhaar numbers.

EPF Contribution Rates

Both the employer and employee contribute 12% of the employee's basic wages plus dearness allowance. Under the new Labour Codes, with the 50% basic salary rule now in effect, the contribution base has effectively increased for most employees.

Note: For smaller establishments with fewer than 20 employees, the contribution rate is 10% instead of 12%. Women employees contribute 8% for their first three years of service. The EPF interest rate recommended by the Central Board of Trustees for FY 2025-26 is 8.25% per annum (subject to government approval before credit).

EPF Payment Deadlines

EPF contributions must be deposited by the 15th of the following month using the ECR (Electronic Challan cum Return) on the EPFO Unified Portal. For example, EPF for March 2026 wages must be deposited by 15 April 2026. Late payment attracts damages ranging from 5% to 25% of the arrear amount, depending on the period of delay, plus interest at 12% per annum.

Employees' State Insurance (ESI): Registration and Compliance

When ESI Registration Is Required

ESI registration through the Employees' State Insurance Corporation (ESIC) is mandatory for establishments with 10 or more employees where any employee earns gross wages up to INR 21,000 per month. Under the Code on Social Security, 2020, the "notified area" restriction has been removed — ESI is now applicable pan-India.

Registration is done online through the ESIC portal (esic.gov.in). The employer receives a 17-digit establishment code. Each covered employee receives an insurance number linked to their Aadhaar and bank account.

ESI Contribution Rates

Employees earning a daily average wage of up to INR 176 are exempt from paying the employee's share, but the employer must still contribute 3.25% for these employees. Once an employee's gross wages exceed INR 21,000, they exit ESI coverage at the end of that contribution period, but the employer's obligation for other covered employees continues.

ESI Payment Deadlines and Returns

ESI contributions must be deposited by the 15th of the following month through the ESIC portal. The contribution period runs in two six-month cycles: April to September and October to March. Half-yearly returns are filed within 42 days of the end of each contribution period — by 12 November (for April-September) and 12 May (for October-March).

Late payment attracts a daily penalty of 12% per annum of the contribution amount. In serious cases, ESIC can prosecute defaulting employers.

Professional Tax: State-Level Payroll Deduction

What Is Professional Tax?

Professional tax (PT) is a state-level tax on employment income, levied by state governments. Not all states levy professional tax — it is currently applicable in Maharashtra, Karnataka, Tamil Nadu, West Bengal, Andhra Pradesh, Telangana, Gujarat, Madhya Pradesh, Kerala, Assam, Meghalaya, Odisha, Jharkhand, Chhattisgarh, Tripura, Sikkim, Puducherry, Manipur, Mizoram, and Nagaland. The Constitution of India caps professional tax at INR 2,500 per person per year.

Key State Rates for FY 2026-27

The employer must register for professional tax in the state where the establishment is located. Registration is typically done through the state's commercial tax or labour department portal. The employer deducts PT from each eligible employee's salary and remits it to the state government, usually by the last day of the following month.

Common Mistakes with Professional Tax

Foreign companies frequently make these professional tax errors:

• Missing registration in new states: When you open a new office in a different state, separate PT registration is required
• Applying wrong state's slab: PT rates vary significantly by state — Maharashtra charges men from INR 7,501 while Karnataka exempts everyone below INR 25,000
• Forgetting the employer's own liability: In most states, the employer must also pay PT on the business itself, in addition to deducting from employees
• Gender-specific slabs: Maharashtra has different thresholds for men and women, a distinction most payroll software does not handle by default

Payroll Setup: Step-by-Step Process

Step 1: Obtain PAN and TAN

Your Indian entity needs a Permanent Account Number (PAN) for all tax filings and a TAN for TDS deductions. PAN is issued at incorporation through SPICe+. TAN must be applied for separately through Form 49B if not obtained during incorporation.

Step 2: Open a Payroll Bank Account

Open a current account with an authorised dealer bank designated for salary payments. Many foreign companies maintain a separate salary account to streamline reconciliation. The bank must be enabled for EPFO and ESIC electronic payments.

Step 3: Register with EPFO

Complete EPFO registration through the Unified Portal within one month of employing your 20th worker (or voluntarily from the start). Collect Aadhaar numbers, bank account details, and UAN (Universal Account Number) for existing employees who had prior EPF accounts. New employees will be assigned UANs upon registration.

Step 4: Register with ESIC

If any employee earns below INR 21,000 gross per month and your establishment has 10+ employees, register on the ESIC portal. Obtain the 17-digit establishment code. Employees will receive ESI numbers and can access medical benefits through ESIC hospitals and dispensaries.

Step 5: Register for Professional Tax

Register in the state where your establishment is located. The registration process varies by state — Maharashtra uses the GST Maha portal, Karnataka has the e-HRMS portal, and other states have their own systems. Obtain the PTEC (Professional Tax Enrolment Certificate) for the establishment and PTRC (Professional Tax Registration Certificate) for deducting from employees.

Step 6: Configure Payroll Software

Configure your payroll system to handle the following calculations accurately:

• TDS calculation per employee based on declared regime and investments
• EPF at 12% of basic + DA (with 13% total employer outgo including admin charges)
• ESI at 0.75% employee and 3.25% employer on gross wages (for covered employees)
• Professional tax per applicable state slab
• The 50% basic salary rule under the new Labour Codes
• GST on reverse charge for any international service payments

Step 7: Run First Payroll

Your first payroll run should include a test cycle at least one week before the actual salary date. Verify all calculations manually for at least 5-10 employees across different salary bands. Confirm that net pay matches gross minus all deductions. Generate payslips that itemise every component — this is a legal requirement under the Code on Wages.

Monthly Payroll Compliance Calendar

Foreign employers must track these recurring monthly and quarterly deadlines:

Missing even one deadline in the first year of operations is common among foreign companies without experienced local payroll teams. Consider engaging a professional tax advisory service for at least the first 12 months.

International Workers: Special EPF Rules

Foreign employees working in India (holding non-Indian passports) are classified as "International Workers" under EPF regulations. Key provisions:

• EPF contribution is mandatory on full salary (no INR 15,000 ceiling) unless the employee's home country has a Social Security Agreement (SSA) with India
• India has operational SSAs with around 18 countries including Belgium, Germany, France, South Korea, Japan, Netherlands, and Luxembourg
• Employees from SSA countries can claim exemption by producing a Certificate of Coverage from their home country's social security authority
• The employer must file a separate monthly return for international workers by the 25th of the following month

This is a frequently missed compliance point. If your foreign parent company sends expatriates to the Indian subsidiary, EPF on full salary can add 24% (employer + employee) on top of an already-expensive expat compensation package.

Key Takeaways

• Register before your first hire: EPFO, ESIC, TAN, and professional tax registrations must be completed before disbursing the first salary. Retroactive compliance attracts penalties and interest.
• Track four separate deadlines monthly: TDS by the 7th, EPF and ESI by the 15th, and professional tax by month-end. A single compliance calendar covering all obligations is essential.
• The 50% basic salary rule changes everything: Ensure your salary structures comply with the new Labour Codes before running payroll. The wage base for EPF, ESI, and gratuity is now higher.
• Professional tax varies by state and gender: If you have offices in multiple states, you need separate PT registrations and correct slab application for each location.
• International workers face full-salary EPF: Unless covered by a Social Security Agreement, foreign employees in India must contribute EPF on their entire salary — not just the INR 15,000 ceiling that applies to Indian employees. Professional compliance support can help avoid costly mistakes.