Setting Up Payroll: PF, ESI & TDS from Day One

Why Payroll Compliance Cannot Wait

When a foreign company sets up a private limited company or wholly owned subsidiary in India, payroll compliance is not a phase-two activity. Indian labour laws require employers to register for Provident Fund (PF), Employee State Insurance (ESI), and Tax Deducted at Source (TDS) before or concurrently with hiring their first employees. Delaying registration by even 30 days can trigger penalties, and retroactive compliance is both expensive and operationally disruptive.

Unlike jurisdictions where payroll taxes are consolidated into a single system, India fragments payroll compliance across four separate authorities: the Employees' Provident Fund Organisation (EPFO), the Employees' State Insurance Corporation (ESIC), the Income Tax Department (for TDS), and state-level Professional Tax departments. Each authority has its own registration portal, contribution rates, filing deadlines, and penalty structures.

This guide walks you through every step of setting up payroll compliance in India for FY 2026-27, with current rates, real deadlines, and practical advice for foreign companies building their first Indian team.

Step 1: Obtain PAN and TAN Before Anything Else

Before registering for any payroll-related compliance, your Indian entity needs two foundational tax identifiers:

• PAN (Permanent Account Number): A 10-character alphanumeric identifier issued by the Income Tax Department. Your company receives a PAN during or immediately after incorporation through the SPICe+ process. Without a PAN, you cannot open a bank account, file tax returns, or register for PF/ESI.
• TAN (Tax Deduction and Collection Account Number): A separate 10-character identifier required specifically for TDS compliance. You must apply for TAN using Form 49B on the NSDL/Protean portal. Processing takes 7-15 working days. You cannot deduct or deposit TDS without a TAN.

Both identifiers are prerequisites for PF and ESI registration. If your incorporation agent did not apply for TAN alongside PAN during the SPICe+ process, do it immediately -- this is the single most common bottleneck that delays payroll setup for new foreign subsidiaries.

Step 2: Employees' Provident Fund (EPF) Registration

When Registration Is Mandatory

EPF registration is mandatory once your establishment employs 20 or more persons (including contract workers). However, establishments with fewer than 20 employees can voluntarily register, and most foreign subsidiaries do so from day one -- it is a standard employee benefit expectation in India and signals organisational credibility.

Once registered, you remain covered under the EPF Act even if your headcount subsequently drops below 20. There is no de-registration mechanism based on reduced employee count.

Registration Process

1. Visit the EPFO Unified Portal at unifiedportal-emp.epfindia.gov.in
2. Click 'Establishment Registration' and create an employer account using the company PAN
3. Submit details of the authorised signatory (typically a director), establishment address, employee count, and nature of business
4. Upload required documents: PAN card, proof of address (utility bill not older than 2 months), certificate of incorporation, cancelled cheque or bank statement, Digital Signature Certificate (DSC) of the authorised signatory
5. EPFO processes the application and assigns an Establishment Code within 3-7 working days

Contribution Rates for FY 2026-27

Both employer and employee contribute 12% of the employee's basic salary plus dearness allowance (DA). However, the employer's 12% is split across multiple sub-accounts:

The effective employer cost is approximately 13% of basic salary, not the headline 12%. For a team of 25 employees with an average basic salary of INR 50,000, this adds up to INR 1,62,500 per month in employer PF contributions alone.

Special Provisions

• Women employees: Female employees contribute only 8% (not 12%) for the first three years of employment, while the employer continues contributing 12%
• Wage ceiling: The statutory wage ceiling for PF contributions is INR 15,000 per month for EPS purposes. The EPF contribution itself has no ceiling -- many companies voluntarily restrict contributions to INR 15,000 basic salary, though employees can opt for higher contributions on actual basic salary
• EPF interest rate: Currently 8.25% per annum for FY 2026-27

Monthly Deadline

EPF contributions must be deposited by the 15th of the following month. Late payment attracts damages ranging from 5% to 25% of the amount due, depending on the delay period -- this penalty structure is punitive by design and compounds rapidly.

Step 3: Employee State Insurance (ESI) Registration

When Registration Is Mandatory

ESI registration is mandatory for establishments with 10 or more employees (20 or more in some states) where at least one employee earns a gross monthly salary of INR 21,000 or less. Once registered, the establishment remains covered even if all employees subsequently earn above the threshold.

For foreign companies building tech teams where starting salaries often exceed INR 21,000 per month, ESI applicability may be limited initially. However, if you hire administrative staff, office support, or junior roles at salaries below INR 21,000, ESI registration becomes mandatory for the entire establishment.

Registration Process

1. Register online at esic.gov.in using the 'Employer Registration' link
2. Enter the company PAN, establishment details, and employee information
3. Upload documents: certificate of incorporation, PAN card, address proof, bank account details, list of employees with Aadhaar numbers
4. ESIC issues a 17-digit Employer Code within 7-10 working days

Contribution Rates for FY 2026-27

Employees earning a daily average wage of up to INR 176 are exempt from the employee contribution -- the employer still contributes 3.25% for these employees.

Wage Ceiling and Proposed Changes

The current ESI wage ceiling is INR 21,000 per month (INR 25,000 for persons with disabilities). The government has proposed increasing this ceiling to INR 25,000 or even INR 30,000, which would significantly expand the coverage base. Monitor this closely -- if the ceiling increases, more of your employees will fall under ESI, increasing your contribution burden.

Benefits ESI Provides

ESI is not merely a payroll tax -- it provides tangible benefits including medical treatment for employees and dependants, sickness cash benefit (70% of wages for up to 91 days), maternity benefit (full wages for 26 weeks), and disability benefit. These benefits partially offset the employer's cost because ESI-covered employees do not need separate group health insurance for basic medical needs.

Monthly Deadline

ESI contributions must be deposited by the 15th of the following month, coinciding with the EPF deadline. The ESIC portal allows combined challan generation for both employer and employee shares.

Step 4: TDS on Salaries (Section 192)

How TDS Works on Salaries

Under Section 192 of the Income Tax Act, every employer paying salary must deduct income tax at source. Unlike other TDS sections that apply fixed rates, TDS on salary is calculated based on the employee's estimated annual income and the applicable tax slab rates under their chosen regime.

The employer must estimate each employee's total salary income for the financial year, apply the relevant deductions and exemptions (if the employee has opted for the old tax regime), compute the annual tax liability, and divide by the number of remaining pay periods to determine the monthly TDS amount.

New Tax Regime Slabs for FY 2026-27

The new tax regime is the default regime for all employees from FY 2024-25 onwards under Section 115BAC. Employees may opt out and choose the old regime, but they must inform the employer at the start of the financial year.

Under the new regime, employees earning up to INR 12,00,000 pay zero tax due to the enhanced Section 87A rebate. For salaried employees, factoring in the standard deduction of INR 75,000, the effective tax-free income extends to INR 12,75,000.

TDS Deposit and Filing Deadlines

• Monthly TDS deposit: By the 7th of the following month (for all months except March)
• March TDS deposit: By April 30
• Quarterly TDS return (Form 24Q): Due by July 31, October 31, January 31, and May 31 for Q1-Q4 respectively
• Form 16 issuance: By June 15 following the financial year end -- this is the TDS certificate each employee needs for filing their personal tax return

Penalty for Non-Compliance

Failure to deduct TDS attracts a penalty equal to the amount of TDS that should have been deducted. Late deposit of deducted TDS attracts interest at 1.5% per month. Late filing of quarterly TDS returns attracts a fee of INR 200 per day under Section 234E, capped at the total TDS amount. Non-filing can result in prosecution proceedings under Section 276B.

Step 5: Professional Tax Registration

What Is Professional Tax

Professional Tax is a state-level levy on salaried employees and professionals, capped at INR 2,500 per person per year under Article 276(2) of the Constitution. Despite the modest per-employee amount, the administrative overhead is significant because every state has different rates, slabs, and filing frequencies.

Registration Requirement

The employer must obtain a Professional Tax Registration Certificate (PTRC) in every state where employees are located. This means a company with employees in Mumbai, Bengaluru, and Hyderabad needs three separate PTRC registrations and must file returns in each state independently.

State-Wise Rates for FY 2026-27 (Key States)

Note that Tamil Nadu, Delhi, Rajasthan, and a few other states do not levy Professional Tax. If your employees are exclusively in these states, you can skip this registration entirely.

Step 6: Gratuity Obligations

Applicability

The Payment of Gratuity Act, 1972 applies to establishments with 10 or more employees. Employees become eligible for gratuity after completing 5 years of continuous service (reduced to 1 year for fixed-term employees under the new labour codes that took effect in November 2025).

Calculation Formula

Gratuity = (Last Drawn Basic Salary + DA) x 15 x Completed Years of Service / 26

The maximum tax-exempt gratuity is INR 20,00,000. Under the new labour codes, basic salary plus DA must constitute at least 50% of CTC, which significantly increases the gratuity base for many employees and correspondingly increases the employer's liability.

Practical Impact for Foreign Companies

While gratuity is payable only upon separation after 5 years of service, prudent companies provision for it from day one. The annual provisioning cost is approximately 4.81% of basic salary. For a 30-person team with average basic salary of INR 40,000, annual gratuity provisioning is approximately INR 6,93,000 -- a cost that many foreign companies discover only when their first employee crosses the 5-year mark.

Step 7: Structuring the Salary for Compliance Optimisation

CTC vs. Gross vs. Net -- The Indian Salary Anatomy

Indian salary structures differ fundamentally from Western models. The Cost to Company (CTC) includes employer PF contributions, ESI, gratuity provisioning, and other employer-side costs. The gross salary is what appears on the payslip before employee deductions. The net (take-home) salary is what the employee actually receives after PF, ESI, TDS, and Professional Tax deductions.

New Labour Code Impact on Salary Structuring

Under the Code on Wages, 2019 (implemented with effect from November 2025), basic salary plus dearness allowance must constitute at least 50% of the employee's total remuneration. This structural requirement has significant implications:

• Higher basic salary means higher PF and gratuity contributions
• Employee take-home pay decreases by 3-5% on average
• Retirement benefits increase substantially
• Companies that had structured salaries with a low basic component (e.g., 30-40% of CTC) must restructure

Sample Salary Breakdown (CTC of INR 10,00,000 per annum)

The employee's take-home from this CTC is approximately INR 62,000-65,000 per month after PF (12%), TDS (based on slab), and Professional Tax deductions. Foreign companies accustomed to quoting gross salaries often experience sticker shock when they see how much of the CTC goes to statutory contributions.

Step 8: Monthly Payroll Compliance Calendar

Once your payroll is set up, compliance is a monthly exercise with zero tolerance for delays. Here is the definitive monthly calendar:

Missing any of these deadlines triggers automatic penalties. There is no grace period and no warning system. Set up automated reminders or engage a payroll service provider with compliance tracking from the start.

Common Mistakes Foreign Companies Make

Mistake 1: Treating Contractors as Employees (or Vice Versa)

Misclassifying workers is the most expensive payroll mistake in India. If a worker classified as a contractor is later deemed an employee by the PF or ESI authorities, the company must pay retrospective contributions plus damages for the entire period of employment. This can run into lakhs of rupees for even a small team. See our detailed guide on hiring contractors vs employees in India for classification criteria.

Mistake 2: Using the Parent Company's Payroll System

Western payroll systems (ADP, Gusto, Paylocity) do not handle Indian statutory components. Indian payroll requires PF/ESI calculations with specific wage ceilings, income tax computation under two alternative regimes, state-specific Professional Tax logic, and challan generation in formats prescribed by Indian authorities. Use an India-specific payroll platform (Razorpay, greytHR, Zoho Payroll, Keka) or outsource to a local payroll provider.

Mistake 3: Not Registering for PF/ESI Before the First Hire

Registration takes 7-15 working days. If you hire employees before registration is complete, you owe contributions from day one but cannot deposit them until the registration is processed. This creates immediate non-compliance and the penalty clock starts ticking.

Mistake 4: Ignoring the UAN Assignment Process

Every employee needs a Universal Account Number (UAN) for PF. If an employee has an existing UAN from a previous employer, you must link it -- not create a new one. Duplicate UANs create downstream problems when employees try to withdraw or transfer PF balances.

Payroll Setup Checklist for Foreign Companies

1. Obtain PAN (during incorporation) and TAN (Form 49B, 7-15 days)
2. Open a corporate bank account (requires PAN, registered office proof)
3. Register on the EPFO Unified Portal (3-7 working days)
4. Register on the ESIC Portal (7-10 working days, if applicable)
5. Register for Professional Tax (PTRC) in every state with employees
6. Select an India-compatible payroll platform or service provider
7. Configure salary structures compliant with the 50% basic wage rule
8. Assign or link UANs for all employees
9. Set up automated challan generation and payment schedules
10. Build a compliance calendar with automated reminders for all deadlines

For comprehensive support in setting up your Indian subsidiary's payroll infrastructure, explore our annual compliance services which include payroll compliance management. If you are still evaluating whether to establish a subsidiary or use an alternative structure, our branch office vs subsidiary comparison covers the compliance implications of each option.

Key Takeaways

• Register for PAN, TAN, EPF, ESI, and Professional Tax before or concurrently with your first hire -- retroactive compliance is expensive and operationally painful
• The employer's real PF cost is 13%, not 12% -- admin charges and EDLI add approximately 1% above the headline contribution rate
• TDS on salaries must be deposited by the 7th of each month -- late deposit attracts 1.5% interest per month, and late filing of Form 24Q costs INR 200 per day
• The new labour codes require basic salary to be at least 50% of CTC -- restructure salary components to comply, which increases PF and gratuity obligations
• Use an India-specific payroll system from day one -- Western payroll platforms cannot handle Indian statutory components, and manual processing at scale guarantees compliance failures