Payroll basics: PF, ESI and professional tax

In short

Payroll is the monthly process of computing what each employee has earned, deducting what law and the employer require, paying the net amount and depositing the deductions with the right authority on time. The three core statutory deductions in India are Provident Fund (EPF, retirement savings under the EPF & MP Act 1952), ESI (health insurance under the ESI Act 1948) and professional tax (a state levy on income from employment). Payroll is examined in B.Com papers on Cost Accounting (labour cost), Business Law / Industrial Law and Income Tax (salary head), and is a standard technical round for accounts-executive, payroll-executive, HR-operations and audit roles. Errors here create interest, damages and penal liability for the employer, so recruiters test the rates, wage ceilings and due dates precisely.

Explained

Salary structure: CTC, gross, net and the wage definitions

• CTC (cost to company): everything the employer spends - gross salary + employer PF + employer ESI + gratuity provision + bonus + insurance. It is not a legal term and never appears on a payslip.
• Gross salary: basic + dearness allowance (DA) + HRA + conveyance + special allowance + other allowances, before deductions.
• Net (take-home) pay: gross − employee deductions (PF, ESI, professional tax, TDS, advances, loan EMI, LWF).
• Basic + DA is the base for PF, gratuity and bonus; gross earnings (excluding annual payments) is the base for ESI; total earnings decide the professional-tax slab.
• Earnings vs deductions: earnings are either fixed (basic, HRA) or variable (overtime, incentive, attendance-linked); deductions are statutory (PF, ESI, PT, TDS, LWF) or non-statutory (canteen, loan, notice-pay recovery).
• Code on Wages, 2019 introduces a single definition of "wages" with the rule that excluded allowances cannot exceed 50% of total remuneration - any excess is added back to wages for PF, gratuity and bonus. The four labour codes have been notified but the provisions were still being brought into force in stages; current practice continues under the existing Acts until the codes are enforced, so verify the position before applying.

Provident Fund (EPF & MP Act, 1952)

• Applicability: establishments in a scheduled industry employing 20 or more persons; once covered, always covered. Voluntary coverage is possible.
• Membership: compulsory for employees whose PF wages (basic + DA) are up to ₹15,000 per month at joining. Those above ₹15,000 who were never members may be treated as excluded employees, but most employers enrol them voluntarily.
• Contribution rate: 12% of basic + DA (and retaining allowance, cash value of food concession) from the employee, matched by 12% from the employer. For certain establishments (fewer than 20 employees, beedi, brick, jute, coir, guar gum, or sick units declared by BIFR) the rate is 10%.
• Statutory wage ceiling: ₹15,000. Employer contribution may be restricted to 12% of ₹15,000 = ₹1,800. Many employers contribute on actual basic - that is permitted, and the choice must be applied consistently.
• Split of the employer's 12%: 8.33% to EPS (Employees' Pension Scheme, capped at 8.33% of ₹15,000 = ₹1,250) and the balance (minimum 3.67%) to EPF. The employee's whole 12% goes to EPF.
• Additional employer charges: EDLI 0.50% (Employees' Deposit Linked Insurance, on wages up to ₹15,000) and administration charges 0.50% of PF wages, subject to a monthly minimum per establishment. EDLI administration charges have been waived. The employee pays no admin charge.
• UAN: the 12-digit Universal Account Number links every PF account of an employee; KYC-seeded UAN lets the member transfer or withdraw online. Passbook and claims run through the EPFO member portal.
• Interest: declared annually by the EPFO Central Board and credited to the member's account; it is compounded on monthly running balances.
• Withdrawal and taxability: the accumulated balance is exempt if the member has 5 years of continuous service (periods with different covered employers, if transferred, count together). Earlier withdrawal above the threshold attracts TDS. Interest on the employee's own contribution above ₹2.5 lakh a year (₹5 lakh where the employer does not contribute) is taxable.
• Advances: partial withdrawal is allowed for housing, marriage, illness, education and specified emergencies, subject to service and purpose conditions.
• Related schemes: EPS pays a monthly pension after 58 years with 10 years' eligible service; EDLI pays a lump sum to the nominee on death in service.
• Return and payment: one monthly ECR (electronic challan-cum-return) uploaded on the EPFO unified portal with the challan paid by the 15th of the following month. Late payment attracts interest at 12% p.a. under section 7Q plus damages under section 14B (graded by delay, up to 25% p.a.).

Employees' State Insurance (ESI Act, 1948)

• Purpose: contributory social insurance giving medical, sickness, maternity, disablement and dependants' benefits through ESIC hospitals and dispensaries.
• Applicability: factories and notified establishments (shops, hotels, restaurants, cinemas, road transport, newspapers, educational and medical institutions) employing 10 or more persons in most states - 20 in a few states such as Maharashtra and Chandigarh - in implemented areas.
• Coverage ceiling: employees drawing gross wages up to ₹21,000 per month (₹25,000 for employees with disability). Above that they are out of coverage.
• Contribution rates (from 1 July 2019): employee 0.75% and employer 3.25% of gross wages - total 4%. Earlier rates were 1.75% and 4.75%.
• Low-wage exemption: an employee earning an average daily wage up to ₹176 pays no contribution, but the employer still pays 3.25%.
• Wages for ESI: all monthly earnings including overtime - but overtime is not counted when testing the ₹21,000 ceiling. Annual or periodic payments (bonus paid yearly, gratuity) are excluded.
• Contribution periods and benefit periods: contribution periods are April-September and October-March; the corresponding benefit periods start three months later (January-June and July-December). A member who crosses ₹21,000 mid-period continues to contribute till the end of that contribution period.
• Benefits: medical benefit (full treatment for the insured person and family), sickness benefit about 70% of wages for up to 91 days a year, extended sickness benefit for long illnesses, maternity benefit about 100% of wages for 26 weeks, temporary/permanent disablement benefit about 90%, dependants' benefit, funeral expenses and the Atal Beemit Vyakti Kalyan Yojana unemployment relief. Benefit entitlement depends on the contributory days in the relevant period.
• Return and payment: monthly contribution filed and paid online by the 15th of the following month; interest at 12% p.a. for delay plus damages. Form 01 for registration, Form 1 declaration for employees, and the insurance number / Pehchan card identify the member.
• No ESI, no PF? They are separate - an establishment can be covered by one and not the other, since thresholds and wage ceilings differ.

Professional tax (state levy)

• Authority: Article 276 of the Constitution permits states to tax professions, trades, callings and employments; the ceiling is ₹2,500 per person per year. Levied under each state's own Act (for example the Maharashtra State Tax on Professions, Trades, Callings and Employments Act, 1975).
• Not levied everywhere: states and union territories including Delhi, Haryana, Uttar Pradesh, Rajasthan, Punjab (which levies a development tax instead), Uttarakhand and Himachal Pradesh have no employment professional tax, or levy it differently. States that levy it include Maharashtra, Karnataka, West Bengal, Tamil Nadu, Andhra Pradesh, Telangana, Gujarat, Madhya Pradesh, Kerala, Assam, Odisha and Bihar. Slabs change with state budgets - always check the current state notification.
• Two registrations: PTEC (enrolment certificate) - the employer / professional pays for itself, usually ₹2,500 a year; PTRC (registration certificate) - the employer deducts from employees' salaries and deposits it.
• Who bears it: the employee bears salary professional tax; the employer is only the deducting and depositing agent and is liable for the lapse if it fails. It is deducted on gross salary slabs, is a flat rupee amount (not a percentage), and is capped at ₹2,500 a year.
• Deposit frequency: monthly where the previous year's liability is large, otherwise annually, with returns in the state's prescribed form - in Maharashtra, monthly if the previous year's PT liability was ₹50,000 or more, else annually by 31 March.
• Income-tax treatment: professional tax actually paid is a deduction from gross salary under section 16(iii) while computing income under the head Salaries - unlike PF, which is a Chapter VI-A deduction under section 80C.

TDS on salary and other payroll statutes

• TDS (section 192): the employer estimates annual taxable salary, allows exemptions and deductions, computes tax under the chosen regime and deducts it in roughly equal monthly instalments. Under the new regime (section 115BAC), which is the default, most exemptions are unavailable but slab rates are lower; the employee may opt for the old regime. Deposit by the 7th of the following month (30 April for March), quarterly return Form 24Q, annual certificate Form 16.
• Gratuity (Payment of Gratuity Act, 1972): 10 or more employees; payable after 5 years of continuous service at 15 days' wages per completed year based on last drawn basic + DA; statutory ceiling ₹20 lakh; exempt under section 10(10) within limits.
• Bonus (Payment of Bonus Act, 1965): 20 or more employees; eligibility wage limit ₹21,000, bonus computed on ₹7,000 or the minimum wage, whichever is higher; minimum 8.33% and maximum 20% of such wages; 30 days' work in the year required.
• Minimum Wages Act, 1948: state-notified minimum wages by scheduled employment, skill level and zone, revised with the VDA (variable dearness allowance) - payroll must never pay below this, and PF cannot be computed on a figure below minimum wages.
• Labour Welfare Fund: small monthly or half-yearly contribution from employee and employer in states such as Maharashtra, Karnataka, Gujarat, Tamil Nadu and Haryana.
• Payment of Wages Act, 1936 / Code on Wages: wages to be paid by the 7th of the following month (10th where 1,000 or more are employed), by bank transfer or cheque; permissible deductions are listed and total deductions are capped (generally 50% of wages, 75% where co-operative recoveries apply).
• Records: muster roll and attendance, wage register, register of deductions, payslip issued to each employee, PF/ESI monthly returns, reconciliation of the payroll register with the salary GL and the bank payment file.

Payroll process, controls and accounting

1. Inputs: master data (joining, salary structure, PF/ESI/UAN numbers, state of work, regime choice), attendance and leave, overtime, new joiners and exits, revisions, loan and advance schedules.
2. Compute earnings: pro-rate for part-month employees on payable days; add overtime, incentives and arrears.
3. Compute deductions: PF on basic + DA, ESI on gross, professional tax from the state slab, TDS, LWF, recoveries.
4. Review: variance against last month employee-by-employee, negative-net check, duplicate bank account / PAN check, headcount reconciliation.
5. Approve and disburse: bank advice or NEFT file; payslips released.
6. Deposit statutory dues: PF ECR and ESI by the 15th, TDS by the 7th, PT per state rule.
7. Account for it: debit Salaries & Wages and Employer PF/ESI expense; credit the payable accounts; clear each liability when paid.
8. Full-and-final settlement on exit: notice period, leave encashment, gratuity, recovery of advances, PF/ESI closure, Form 16.
9. Segregation of duties is the key control: the person who maintains the employee master must not be the one who releases the bank payment.
10. Advantages of a compliant payroll: no interest or damages, employees get credited social security, audit and due diligence pass cleanly. Limitations: rates, ceilings and state slabs change often, multi-state operations multiply registrations, and the ₹15,000 / ₹21,000 ceilings mean most mid-level employees get no ESI cover at all.

Key points

• PF applicability - 20 or more employees; ESI applicability - 10 or more (20 in a few states); both are irreversible once covered.
• PF wages - basic + DA (+ retaining allowance); ESI wages - gross monthly earnings including overtime; PT - on gross salary slabs.
• PF rate - 12% employee + 12% employer; 10% for specified/small establishments.
• PF ceiling - ₹15,000 of basic + DA, so the capped employer share is ₹1,800 a month.
• EPS split - 8.33% of the employer's share to pension, capped at ₹1,250; balance minimum 3.67% to EPF.
• Employer extras - EDLI 0.50% and PF administration charges 0.50%, both employer-borne.
• ESI rates - employee 0.75% + employer 3.25% = 4% of gross (since 1 July 2019).
• ESI ceiling - ₹21,000 gross (₹25,000 for persons with disability); overtime ignored for the ceiling test.
• ESI daily-wage exemption - up to ₹176 average daily wage, employee exempt but employer still pays.
• Contribution periods - ESI April-September and October-March, with benefit periods three months later.
• Due dates - PF and ESI by the 15th, TDS by the 7th (March by 30 April), wages by the 7th or 10th.
• Professional tax - state levy under Article 276, maximum ₹2,500 per person per year; PTEC for the employer, PTRC for employee deductions.
• Tax treatment - PT deducted under section 16(iii); employee PF qualifies under section 80C; employer PF is not the employee's income within limits.
• Gratuity - 15 days' last drawn basic + DA per completed year after 5 years, ceiling ₹20 lakh.
• Bonus - 8.33% to 20%, eligibility ₹21,000, computed on ₹7,000 or minimum wage, whichever is higher.
• Late payment - PF interest 12% p.a. under section 7Q plus damages under section 14B; ESI 12% p.a. plus damages.
• CTC is not a statutory concept - gross is what the payslip shows, net is what the bank credits.
• Code on Wages - single wage definition with the 50% exclusion rule; notified but being brought into force in stages, so confirm the current position.

Formulas and examples

Rupee amounts are per month unless stated; percentages apply to the wage base named alongside them; PF rounding is to the nearest rupee and ESI is rounded up to the next rupee.

Example 1 - Full payslip for an employee covered by both PF and ESI (Maharashtra). Basic ₹12,000, DA ₹2,000, HRA ₹5,600, conveyance ₹1,600, special allowance ₹1,800. Full month worked; PF on actual basic + DA (below the ceiling anyway), old-regime TDS nil because total income is below the taxable limit.

1. PF wages = 12,000 + 2,000 = ₹14,000; Gross = 14,000 + 5,600 + 1,600 + 1,800 = ₹23,000.
2. Employee PF = 12% × 14,000 = ₹1,680. Employer PF = 12% × 14,000 = ₹1,680, split EPS 8.33% × 14,000 = ₹1,166 and EPF ₹514.
3. EDLI = 0.50% × 14,000 = ₹70; admin = 0.50% × 14,000 = ₹70.
4. ESI: gross ₹23,000 exceeds ₹21,000, so the employee is outside ESI - no ESI either side.
5. Professional tax (Maharashtra: a male employee on more than ₹10,000 a month pays ₹200, ₹300 in February; a woman employee is exempt up to ₹25,000) = ₹200.
6. Net pay = 23,000 − 1,680 − 200 = ₹21,120.
7. CTC for the month = 23,000 + 1,680 + 70 + 70 = ₹24,820 (before gratuity and bonus provision).

Example 2 - Same structure, lower salary, so ESI applies. Basic ₹9,000, DA ₹1,000, HRA ₹4,000, special allowance ₹2,000, overtime ₹1,500.

1. PF wages = 9,000 + 1,000 = ₹10,000 → Employee PF = ₹1,200; employer PF ₹1,200 (EPS 8.33% × 10,000 = ₹833, EPF ₹367).
2. Gross excluding overtime = 9,000 + 1,000 + 4,000 + 2,000 = ₹16,000 → below ₹21,000, so covered (overtime is ignored for the ceiling test).
3. ESI wages including overtime = 16,000 + 1,500 = ₹17,500. Employee ESI = 0.75% × 17,500 = ₹131.25 → ₹132 (rounded up). Employer ESI = 3.25% × 17,500 = ₹568.75 → ₹569.
4. Professional tax (Maharashtra, male employee above ₹10,000) = ₹200.
5. Net pay = 17,500 − 1,200 − 132 − 200 = ₹15,968.
6. Employer cost = 17,500 + 1,200 + 569 + 50 (EDLI 0.50% × 10,000) + 50 (admin) = ₹19,369.

Example 3 - PF ceiling applied versus PF on actual wages. Basic + DA = ₹30,000. The employee contributes 12% on actual wages.

EDLI is always limited to ₹15,000 of wages, which is why its figure does not change. The difference in employer cost is ₹1,875 a month, ₹22,500 a year - the reason most offer letters restrict the employer share to the ceiling.

Example 4 - Pro-rated month, mid-month joining, and the ESI contribution-period rule. An employee joins on 11 September in a 30-day month; monthly gross ₹18,000 (basic + DA ₹9,000). Payable days = 20.

1. Pro-rated gross = 18,000 × 20/30 = ₹12,000; pro-rated basic + DA = 9,000 × 20/30 = ₹6,000.
2. Employee PF = 12% × 6,000 = ₹720; employer PF ₹720 (EPS 8.33% × 6,000 = ₹500, EPF ₹220).
3. Employee ESI = 0.75% × 12,000 = ₹90; employer ESI = 3.25% × 12,000 = ₹390.
4. From 1 October his gross rises to ₹22,000 - above the ceiling. Because the increase falls at the start of the October-March contribution period, he goes out of ESI from October. Had the rise taken effect in, say, December, contributions would have continued on the higher wage until 31 March.

Example 5 - Professional tax, state comparison and gratuity on exit. An employee with monthly gross ₹40,000 works in different states; PT for the year (indicative current slabs - verify against the state notification):

Gratuity on resigning after 7 years 8 months with last drawn basic + DA ₹26,000: service rounds to 8 years (over 6 months counts as a year) → Gratuity = 26,000 × 15/26 × 8 = ₹1,20,000, fully exempt as it is within the ₹20 lakh ceiling and below the 15-days-per-year formula limit.

Where it is used

• Payroll and compliance teams in IT, ITES, BPO, manufacturing, retail and hospitality - monthly ECR upload, ESI filing, PT returns and Form 24Q.
• Third-party payroll and staffing firms - TeamLease, Quess, Randstad, ADP India, Paysquare - where principal-employer liability for contractor PF/ESI is a live audit issue.
• Payroll software and HRMS products - Tally Prime payroll, Zoho Payroll, greytHR, Darwinbox, Keka, SAP SuccessFactors - configured with these rates and slabs.
• Statutory audit and internal audit - vouching the payroll register to the GL, confirming PF/ESI deposits and challans, testing section 43B disallowance of unpaid employer contributions and section 36(1)(va) for delayed employee contributions.
• Job roles - payroll executive, accounts executive, HR operations, compliance officer, articled assistant in CA firms, and labour-law consultants filing on the Shram Suvidha and EPFO/ESIC portals.
• Cost accounting - labour cost, idle time and overtime analysis in manufacturing, where employer PF/ESI forms part of direct or indirect labour cost.

Interview questions

• Q: On what wage is PF calculated, and what is the ceiling? A: On basic + DA (plus retaining allowance and cash value of food concession), at 12% each side; the statutory ceiling is ₹15,000 a month, so the capped contribution is ₹1,800.
• Q: How is the employer's 12% PF share split? A: 8.33% goes to the Employees' Pension Scheme, capped at ₹1,250 (8.33% of ₹15,000), and the balance - a minimum of 3.67% - goes to the EPF account.
• Q: What are the current ESI rates and the coverage limit? A: Employee 0.75% and employer 3.25% of gross wages, total 4% since 1 July 2019, for employees drawing gross wages up to ₹21,000 a month (₹25,000 for employees with disability).
• Q: An employee's salary crosses ₹21,000 in December. When does ESI stop? A: Contributions continue on the higher wage until the end of that contribution period, 31 March, and coverage stops from 1 April.
• Q: Is overtime included in ESI? A: Yes, contributions are payable on overtime, but overtime is excluded when testing whether the employee is within the ₹21,000 coverage ceiling.
• Q: Who bears professional tax, and what is the maximum? A: The employee bears it; the employer only deducts and deposits it. Article 276 caps it at ₹2,500 per person per year, and the slabs differ by state - several states do not levy it at all.
• Q: What is the difference between PTEC and PTRC? A: PTEC is the enrolment certificate under which the employer or professional pays its own professional tax; PTRC is the registration certificate under which it deducts from employees' salaries and remits.
• Q: How are PF and professional tax treated in the employee's income-tax computation? A: Professional tax paid is deducted from salary under section 16(iii); the employee's PF contribution is a Chapter VI-A deduction under section 80C.
• Q: What are the monthly statutory due dates a payroll executive must remember? A: TDS by the 7th, PF ECR and ESI contribution by the 15th, wages by the 7th (10th for establishments with 1,000 or more employees), and professional tax per the state rule.
• Q: What happens if PF is deposited late? A: Interest at 12% p.a. under section 7Q plus damages under section 14B, and the delayed employee contribution is permanently disallowed as a business expense under section 36(1)(va).
• Q: Does the company have any liability for a contractor's workers? A: Yes - as principal employer it must ensure the contractor pays PF and ESI for workers deployed on its premises, and can be made to pay and recover from the contractor.
• Q: When is PF withdrawal tax-free? A: When the member has completed five years of continuous service, counting transferred service with earlier covered employers; interest on own contributions above ₹2.5 lakh a year is taxable regardless.
• Q: Why can two employees with identical CTC have different take-home pay? A: Because the split matters - a higher basic raises PF on both sides, a gross below ₹21,000 brings ESI in, the state decides professional tax, and the tax regime changes TDS.

Common mistakes

• Computing PF on gross salary instead of basic + DA, or ESI on basic instead of gross earnings.
• Treating 8.33% EPS as 8.33% of actual basic without applying the ₹1,250 pension cap.
• Taking the employer's 12% as 12% + EDLI + admin charges, or deducting EDLI and admin from the employee - both are employer-borne.
• Dropping an employee out of ESI the moment wages cross ₹21,000 instead of continuing to the end of the contribution period.
• Including overtime when testing the ₹21,000 ESI ceiling, or excluding it when computing the contribution - the rule is the reverse.
• Quoting the old ESI rates of 1.75% and 4.75%, or the old ₹6,500 PF ceiling, instead of the current figures.
• Applying one professional tax slab to all states, or deducting PT where the state does not levy it; confusing PT (section 16(iii)) with PF (section 80C) in the tax computation.
• Equating CTC with gross pay in an interview, and ignoring that the ₹15,000 and ₹21,000 ceilings, slabs and rates are revised by notification.

Related topics

• Tally Prime basics (payroll vouchers) · Income tax: salary head, TDS and Form 16 · Cost accounting: labour cost and overtime · Industrial and labour law · Month-end close and reconciliations · Careers in commerce: CA, CMA, CS, CFA and jobs