Payroll Processing in India – A complete step by step guideline

payroll processing guide

Payroll Processing in India is an overwhelming process as it constitutes enormous financial elements like gross salary, net salary, bonuses, daily wages, leave, compliances, and many more such elements which are part of each employees’ hire to retire journey with an organization.

Employees are viewed as the most significant asset of an organization. Thus, companies invest a generous amount of time and energy in recruiting, training and setting up an adequate process for each employee. One of the most significant chores in payroll exercise is the processing of the payroll. In a way, employees rely on the company’s process to get paid without any type of delays. Irrespective of the size of the organization, whether small, medium, or large, payroll plays a crucial role in HRM (Human Resource Management).

What is ‘Payroll’?

‘Payroll’ as a term basically is the list of employees who are entitled to receive compensation from an organization. Along with the amount that each employee should receive for the time worked or tasks performed, payroll refers to a company’s financial record of payments that are made to the employees by the employer including wages, salaries, bonuses, incentives, etc. (as per Wikipedia and other sources)

What is Payroll Processing?

Payroll Processing refers to the complete set of steps involved in calculating the total remuneration of each employee. The process typically involves three to four stages and tasks such as defining salary structures, gathering employee data, components, deductions, allowances, and setting up the necessary policies with respect to taxes and other adjustments, and then calculating the total salary after adjusting all the company policies. After the salaries are disbursed, filing, reporting and providing payslips to employees also comes under the entire payroll processing cycle.

In simplest words, if payroll is the amount paid by the employer to employee, payroll processing is the whole methodology to accurately calculate the net pay of the employees as per statutory compliances and company policies.

How is Payroll calculated in India?

The formula,

Net Salary = Gross Salary – Gross Deductions 

here,

Gross Salary = Basic Salary + HRA + All types of Allowances + Reimbursements + Arrears + Bonus 

Gross Deductions = Professional Tax + Public Provident Fund + Income Tax + Insurance + Leave adjustments + Loan repayments (if any)

Recommended read: All you need to know about Salary Structure in India 

Important elements of Salary Structure in India:

  • CTC
  • Gross Salary
  • Net Salary
  • Allowances
  • Prerequisites
  • Deductions
  • Payslip
  • Form-16
  • Reimbursements
  • Bonus/Incentives/Expenses/One-time payments
  • Ad hoc Components
  • Company PAN, TAN, PF, ESI, PT, LWF (if applicable) details
  • Signatory Details
  • Company Bank Details
  • Employee Financial Details
  • Employee Investment Declarations
  • Previous Salary Details
  • Annual CTC / Gross of all the employees

Stages to process Payroll in India

Stages of Payroll

A company’s payroll cycle consists of overall 3 stages

  • Pre-payroll activities
  • Payroll process
  • Post-payroll activities

(Some of the professionals add a fourth stage by dividing the final one-Post Payroll activities into two parts. However, the entire payroll stage is covered in this article)

Both HR and Payroll go hand in hand when it comes to the company’s payroll operations. As an entrepreneur, it’s very important to recognize the importance of payroll processing. The most important yet untouched element in payroll processing is the morale of an employee. If payroll is delayed due to any reason, employees tend to underperform which may end up affecting the company’s revenue in the end. Payroll should always be accurate and on time. Overall payroll processing includes 3 stages.

Let us take a look;

STAGE – 1 / Pre-Payroll Activities

Organizations of any industry cannot deny the fact that payroll is one of the most consequential functions performed in daily business activities as it is related to employee salaries as well as the company’s finance. So as to run an accurate payroll, data inputs are assembled from multiple sources in the company.

Payroll is a time consuming and tedious activity due to the various compliances to be adhered to. For the sake of a smooth payroll process, a sorted-out procedure must be set up to guarantee an error-free payroll. The first phase, in such a process flow, are the pre-payroll activities.

Pre Payroll activities

Below are the activities majorly taken care of, in pre-payroll activities:

  • Understanding taxable, non-taxable and partially taxable components of the salary.
  • Gathering payroll data
  • Data requirements to run a payroll
  • Data validation before proceeding further

Recommended read: What are pre-payroll activities? A detailed overview

Understanding taxable, non-taxable and partially taxable components of salary

While the basic compensation is completely taxable, there are different advantages offered to the employees as allowances and prerequisites. These recompenses are offered to employees for the costs they bear during work and can be totally liberated from tax collection, or they can be taxed, either partially or completely.

A salary slip consists of two categories – Earnings and Deductions, however, the various terms listed under them can be confusing. Moreover, these different components have different tax implications, adding further to the havoc. While some components are fully taxable, some are fully exempt, and few others are partially taxable or tax-exempt based on certain conditions.

Periodically, companies also offer perks to their employees that may or may not have tax liabilities. Here, you will understand the tax implications of the common constituents of salary.

Recommended readTaxable, Non-Taxable and Partially Taxable elements of Salary

Gathering the Data to run Payroll

Gathering the data for processing payroll is a task in itself. The traditional pattern of working towards data assembling is done by paper-based sheets or excel sheets. Using excel sheets is time and energy-consuming. Recent evolution in technology has led to the development of web-based systems. These can be aimed at both managers and employees. There is no doubt that Excel is a very useful tool to create charts, carry out complex calculations and present insights.

However, gathering data and processing payroll is a different venture. This is where an automated cloud-based payroll software as a solution will eliminate the hassles and ensure error-free payroll.
Understand where excel fails and software scores in payroll in the related blog.

Data requirements to run a payroll

  • Leave and attendance data: To accurately process payroll, one of the most important activities in pre-payroll is calculating the time that an employee has invested in a given pay period. Attendance data is the key input for processing payroll as almost all the other calculations are based on it. Any errors in this step will invariably lead to wrong calculation of employees’ compensation, causing employee dissatisfaction. For the HR departments too, it is a time-consuming activity. Along with attendance, it is also important to track whether the employee is spending the stipulated amount of time at work.

Recommended read: Data requirements to run Payroll in India | Gathering Leave and attendance data.

  • Payments and Deductions: One more set of most crucial data to be collected as part of pre-payroll is the information regarding payments and deductions to be made to employees. Payment and deductions data for the specified period helps determine how much is to be paid as salary to a particular employee.

Recommended read: Gathering data to run Payroll in India | Understanding Payments and Deductions

  • Income tax information: According to section 192 of the Income Tax Act, the employer is responsible for deducting income tax (tax deducted at source) while paying salaries to employees. This deduction is based on the estimate of the income that will be earned in the particular financial year and the applicable tax rates.
    As most employees make investments to save tax, organizations ask their employees to declare their investments at the start of the financial year. Based on this declaration of tax-saving investments, the organization calculates the taxable income and the projected tax, which the employee is liable to pay for the financial year. This tax is then deducted on a monthly basis as tax deducted at source. (TDS).

Recommended read: Gathering data to run Payroll in India | Understanding Income Tax

Data validation before actual payroll process

Data validation is the most foremost step of pre-payroll, which can’t be avoided regardless of any cost. The collected data is checked for accuracy and correctness before further using it in the actual payroll process. It is important to confirm that the background work done so far as part of pre-payroll is error-free to ensure that the subsequent activities of payroll run smoothly. Inaccurate data can menace the entire payroll process.

Validation is a proactive step in the sense that it eliminates the risk of committing mistakes in payroll and the consequences faced while rectifying them later.

Recommended read: Data Validation! Gaze before you leap | Pre-Payroll Activities

STAGE 2 / Actual Payroll Processing

This is where real work towards reaching the net compensation of employees happens, in the way of finishing the pre-payroll activities. This is the time when accumulated payroll data (Leave & Attendance data, shift wise calculations, Tax and Deductions, Expenses, Incentives) during pre-payroll should run.

When you feed the validated data into the system, the outcome you will get will be the net compensation after the adjustments of necessary taxes and deductions. In this stage, you also verify the information to achieve accuracy.

Recommended read: Payroll Processing in India | The Actual Payroll Process

Statutory Compliances in India

Statutory compliance in HR refers to the lawful structure and regulations within which organizations must operate while dealing with their employees. Detailed knowledge of legal compliance and expertise is required to minimize the risk associated with the non-compliance of statutory requirements.

Each nation has different sorts of compliance requirements. There are a number of statutory requirements for Indian companies and they have to spend a significant amount of time in their payroll management to ensure that they are compliant with the legal regulations. If companies fail to adhere to statutory compliances, they may need to confront heavy penalties which are several times more than complying with legal guidelines.

The most common statutory compliances that companies have to follow for their payroll management in India are:

  • ESI fund and PF (Provident Funds)
  • Professional Tax
  • TDS (Tax Deduction at Source)
  • Gratuity

While processing actual payroll, the following elements play a major role:

  • Salary Components and Structures Configuration
  • Statutory Compliances
  • Finance settings; HRA, tax consideration for bonus given to employees, ,old/new tax regime
  • IT Declarations-globally
  • IT Declarations-employee
  • Loans facility
  • Freezing the salary by finalizing the payroll

Actual Payroll Processing: the payroll process after gathering data and validating it involves;

  • Running the Payroll
  • Leave attendance and LOP data Recommended read: What is Leave attendance and LOP data in Indian Payroll Processing
  • New joiners and Exits (Full and Final Settlement) Recommended read: Employee Full and Final Settlement: All you need to know
  • Salary revisions, Arrears and Bonus payments Recommended read: Employee Salary Revision, Arrear Processing & Bonus Payments | A detailed run-through
  • One Time Payments/Deductions, expenses, reimbursements Recommended read: All about Employee One Time Payment, Deduction and Expenses | HR and Payroll
  • Salary on hold Recommended read: Salary on hold; All you need to know
  • Reimbursements Recommended read: Understanding Reimbursable components of salary in Indian HR

Running Payroll; Software versus Excel

An Excel sheet is a fantastic tool when used for the right purpose. However, many organizations face problems when they extend the use of excel sheets far beyond their capacity, such as completing the entire payroll process. Payroll is not just computing paychecks, and excel isn’t the best tool for the extensive process.

Recommended read: Running Payroll-Excel versus Software. Which is better?

STAGE 3 /Post Payroll Activities

Post-Payroll Activities in an organization include reporting, declarations, and statements that each employer must produce for the relevant corresponding bodies. In the system, this reporting consists of reports that generate issues and downloads. (As per relevant sources)
Post Payroll activities

Payroll Accounting: Payroll accounting involves a company’s recording of its employees ‘compensation including:

  • Gross wages, salaries, bonuses, commissions, and so on that have been earned by its employees.
  • Withholding of payroll taxes such as income taxes, ESI etc.
  • Withholding for the employees’ expense of health insurance premiums, employees’ contributions to savings plans, garnishments of salaries and wages.
  • Employer’s expense of fringe benefits such as health and dental insurance, paid holidays, vacations and sick days, pension and savings plan contributions, worker compensation insurance, etc.

Payout: Generally, organizations provide salary to employees with a salary bank account. Once the payroll is completed, companies need to ensure that the bank account has sufficient funds to make the salary payment. Then you need to send a salary bank advice statement to the concerned branch. You can pay salary by cash, cheque, or bank transfer.

Reporting: Once, you run the complete payroll process, manually or through any system, your senior authorities as per your company culture, may ask you for the reports such as department wise employee cost, location wise employee cost, etc. As a payroll officer, it becomes your responsibility to dig into the data and extract the required information and share the reports. These reports are automatically created by the professional payroll software whereas; some organizations invest a lot of time in creating those reports manually.

Post Payroll activities explained in brief:

  • Review, generate and issue of Payslips, TDS Reports, Cash Reports.
  • Accessing the Bank Statements and downloading them by choosing a financial year, frequency, period and batch.
  • Employee information like employee count, CTC, gross, and net pay, bonus and loss of pay, commissions, processed date, processed by etc.
  • PF, ESI, & PT challans, to be generated in ECR format and along with arrears.

Recommended read: All you need to know about Post-payroll Activities

Filing

Form 24Q: Form 24Q is used to file the return for tax deducted at source from salary payments.

Form 12B: Form 12B is a statement to be provided by the employer to an employee if he is joining in the middle of the year.

Form 12BB: Form 12BB is an investment declaration form in which employees would mention all investments made by them for tax savings in a financial year.

Form 15H: Form 15H is for senior citizens, those who are 60 years or older to file ITR valid for one financial year.

Form 15G: Form 15G is for everybody else to file ITR valid for one financial year.

Form 16: Form 16 is the certificate issued under section 203 of the Income-tax Act for tax deducted at source (TDS) from income under the head ‘salary’.

Form 16A: Form 16A is the certificate of deduction of tax at source and issued on deduction of tax by the employer on behalf of the employees. These certificates provide details of TDS/TCS for various transactions between deductor and deducted.

Form 16B: Form 16B certifies that the tax has been deducted at source on the income earned from the sale of immovable property (building or part of it) other than agricultural land, and the TDS has been deposited by the property buyer with the Income Tax Department.

Form 10C: Form 10C is filled and submitted when you want to claim benefit under the Employee Pension Scheme (EPS)

Form 26QB: Form 26QB is a return cum challan for payment of TDS to the government.

Form 26AS: Form 26AS (Tax Credit Statement) is the annual statement in which the details of tax credit are maintained for each taxpayer as per the database of the Income-tax department. Form 26AS will reflect the tax credit against the PAN of the taxpayer.

Form 27C: Form 27C is a document that can help in getting tax exemption from the tax deducted at the source. Both buyers and sellers can use this for all the goods specified in the Income Tax Act.

Form 24G: When income tax is deducted at source (TDS) for a salaried individual or a non-salaried individual or even a person who is not a resident of the country, is not salaried but still has to pay tax, the Accounts Officers who process such need to use a form to submit information about the deduction. Form 24G is used to submit such information for processing.

Form 64A: Form 64A contains the statement of income paid or credited by Venture Capital Company and credited by Venture Capital Fund to be furnished under section 115U of the Income Tax Act 1961.

Form 24Q: The employer has to file a salary TDS return in Form 24Q. 24Q is to be submitted on a quarterly basis. Details of salary paid to the employees and TDS deducted on such payment is to be reported in 24Q.

Form 12BA: Form 12BA is a detailed statement showing particulars of perquisites, other fringe benefits, and profits in lieu of salary.

Form 27EQ: Form 27EQ is a quarterly certificate that contains details of the Tax Collected at Source or TCS under Section 206C of the Income Tax Act, 1961.

Form 49B: Form 49B is an application form under section 203A of the Income Tax Act 1961 for the assignment of TAN number or TAN deduction and payment account number.