How to Set Up Payroll for the First Time in India: Complete Step-by-Step Guide

A startup in Noida hired its sixth employee in March 2025. The founder had been managing salary transfers directly from the company bank account - no payslips, no PF deductions, no TDS filing. It worked for five employees. By the sixth, a new hire asked: "What is my UAN number?" The founder did not have one. That one question opened a chain of compliance gaps the company had been sitting on for eight months without realising.

Setting up payroll in India is not just about transferring money to employee bank accounts. It is a compliance system that spans 6 government authorities (Income Tax, EPFO, ESIC, State Labour, State Professional Tax, and Shops & Establishments), 5 types of monthly deductions, and 4 filing deadlines - every single month.

This guide walks you through every step of setting up payroll for the first time - from the registrations you need before your first hire to the monthly payroll cycle that runs every month thereafter. It incorporates the 2025 Labour Code requirements including the 50% basic rule, the 2-day F&F settlement, and mandatory digital record keeping.

What Is Payroll and Why Does It Matter for First-Time Employers?

Payroll in India is the end-to-end process of calculating employee compensation, deducting statutory contributions (PF, ESI, TDS, Professional Tax), disbursing net salary, and filing compliance returns with government authorities. It runs every month without exception - from the month you hire your first employee until the month you close operations.

Getting payroll wrong creates cascading problems. Missed PF contributions accumulate with 12% interest and damages up to 100% of arrears. Missed TDS attracts 1-1.5% interest per month plus prosecution risk. Incorrect salary structuring under the 50% basic rule creates backdated liability from 21 November 2025. And employees who discover their PF was never deposited - despite being deducted from salary - can file criminal complaints.

Employers who want to avoid these risks from day one can explore payroll processing and management services that handle every registration, deduction, filing, and record from the first payroll run - ensuring compliance is built into the system, not bolted on after problems arise.

Key Terms You Should Know

• CTC (Cost to Company): The total annual cost to the employer - includes gross salary + employer PF + employer ESI + gratuity provision + any other employer-borne benefits. CTC is not what the employee receives.
• Gross Salary: CTC minus employer contributions. This is the amount from which employee deductions (PF, ESI, PT, TDS) are subtracted to arrive at net salary (take-home).
• TAN (Tax Deduction Account Number): A 10-digit alphanumeric number issued by the Income Tax Department. Required for every employer who deducts TDS from employee salaries. Must be obtained before the first salary is paid.
• UAN (Universal Account Number): A unique 12-digit number assigned to each employee under the EPF scheme. The UAN stays with the employee for life - even if they change employers. The employer generates the UAN at the time of PF registration.
• Form 24Q: The quarterly TDS return filed by the employer showing employee-wise TDS computation and deduction details. Filed 4 times a year - July 31, October 31, January 31, and May 31.
• Form 16 / Form 130: The annual TDS certificate issued by the employer to each employee. Shows total salary, deductions claimed, TDS deducted, and tax payable/refundable. Form 130 replaces Form 16 from April 2026 under the Income Tax Act 2025.

Who Needs to Set Up Payroll in India?

Any entity that hires even one employee in India must set up a compliant payroll system. There is no "too small" exemption for basic payroll obligations like TDS and minimum wages.

• Startups and new companies - from the date of hiring the first employee
• Foreign companies hiring in India - through own entity, branch office, or Employer of Record
• Freelancers who hire employees (not contractors) - employment relationship triggers payroll obligations
• NGOs, trusts, and section 8 companies - same payroll compliance as for-profit entities
• Companies crossing the PF threshold (20+ employees) - must register within the first month
• Companies crossing the ESI threshold (10+ employees with wages up to Rs 21,000) - must register immediately

Legal Framework: What Laws Govern Payroll in India?

How to Set Up Payroll: Complete 10-Step Process

1. Register your company and obtain PAN.Before anything else, your company must be legally registered - private limited, LLP, or proprietorship. Obtain PAN (Permanent Account Number) for the entity. If you have not yet registered, start with company registration - your PAN is generated as part of the incorporation process.

2. Obtain TAN (Tax Deduction Account Number). Apply for TAN online through the NSDL portal (Form 49B). TAN is mandatory before you can deduct TDS from employee salaries. Processing time is 7-15 days. Without TAN, you cannot file TDS returns or issue Form 16/Form 130 to employees.

3. Register for PF (Provident Fund).PF registration is mandatory once you have 20 or more employees. Register on the EPFO Unified Portal within the first month of crossing the threshold. Back-contributions apply from the date you crossed 20 - not from the date of registration. For PF registration assistance, the process takes 7-10 days with correct documentation - establishment certificate, PAN, Aadhaar of authorised signatory, employee list, and cancelled cheque.

4. Register for ESI (Employee State Insurance).ESI registration is mandatory once you have 10 or more employees (in most states) with monthly wages up to Rs 21,000. Register on the ESIC portal. Both employer (3.25%) and employee (0.75%) contributions are mandatory from the date of crossing the threshold. For ESIC registration assistance, the process can be completed in 5-7 days.

5. Register under the state Shops & Establishments Act. Register your office/establishment with the local municipal authority or labour department within 30 days of commencing business. This is a state-specific requirement - the application form, fees, and process vary by state. The registration certificate must be displayed at the workplace.

6. Register for Professional Tax (if applicable in your state). States like Maharashtra, Karnataka, West Bengal, Telangana, AP, Tamil Nadu, Gujarat, MP, and others levy Professional Tax. Obtain PTRC (employer registration) and PTEC (employer enrolment) as applicable. Deduct PT from employee salary monthly and deposit with the state government.

7. Design the salary structure compliant with the 50% basic rule. Set basic + DA at 50-55% of gross salary (mandatory under Code on Wages). Allocate HRA at 40-50% of basic (50% for metro cities). Add NPS employer contribution (10-14% of basic - most tax-efficient). Use special allowance as the balancing figure. Keep CTC = gross salary + employer PF + employer ESI + gratuity.

8. Collect employee documents and data. For each employee, collect: PAN, Aadhaar, bank account details, UAN (if existing - for PF transfer), tax regime choice (old or new), Form 12BB (investment declaration), rent receipts (for HRA), and emergency contact details. Issue appointment letter with salary breakup to every employee - mandatory under Labour Codes.

9. Configure payroll software or engage a payroll provider.For 10+ employees, use payroll software (Keka, greytHR, Zoho Payroll, or similar) that handles TDS computation, PF/ESI calculation, payslip generation, and statutory filing. For fewer than 10, a CA-managed process works. For any size, payroll outsourcing to a professional firm eliminates all internal compliance burden. Employers managing income tax return filing must ensure that TDS computation matches between Form 24Q (quarterly) and Form 16/Form 130 (annual) - discrepancies trigger IT department notices.

10. Run your first payroll. Lock attendance for the month. Calculate gross salary for each employee. Apply deductions: employee PF (12% of basic, capped at Rs 15,000 statutory), employee ESI (0.75% if applicable), Professional Tax, and TDS (based on projected annual income and regime choice). Calculate net salary. Generate payslips. Transfer net salary to employee bank accounts by the 7th of the following month. Deposit TDS by the 7th. Deposit PF/ESI by the 15th. File Form 24Q quarterly.

Documents Needed from Each Employee

• PAN card copy - mandatory for TDS computation and Form 16
• Aadhaar card copy - mandatory for UAN generation and ESIC enrolment
• Bank account details (cancelled cheque or bank letter) - for salary credit via NEFT/IMPS
• Passport-size photograph - for PF and ESIC records
• Previous employer Form 16 / Form 12B - for mid-year joiners to compute cumulative TDS
• Tax regime choice declaration - old or new regime (affects TDS calculation)
• Form 12BB - investment declaration for HRA, 80C, 80D, home loan, and other deductions
• Rent receipts (for HRA claim) - landlord PAN mandatory if rent exceeds Rs 1 lakh/year
• Educational certificates and experience letters - for employee records
• Emergency contact and nominee details - for PF/ESIC/gratuity nomination

Monthly Payroll Compliance Calendar

Common Mistakes First-Time Employers Make

Mistake 1: Delaying PF registration past the 20-employee threshold. PF registration is mandatory from the month you cross 20 employees. Back-contributions (with interest and damages) apply retroactively from the date you crossed the threshold - not from the date you register. Delaying registration by 6 months can create Rs 2-5 lakh in arrears for a 25-person company.

Mistake 2: Setting basic salary below 50% of CTC. Non-compliant under the Code on Wages 2019 since 21 November 2025. The 50% basic rule is not optional. It triggers recalculation of PF, gratuity, ESI, bonus, overtime, and leave encashment on the higher base. Design the salary structure correctly from day one - restructuring later is far more disruptive.

Mistake 3: Transferring salary from the founder's personal account. Salary must be paid from the company's registered bank account - not the founder's personal account. Payments from personal accounts create tax complications, are not traceable for compliance, and fail inspection scrutiny. Open a company current account and process all salary payments through it.

Mistake 4: Not deducting TDS because employees are "below the tax limit." Even if an employee's projected annual income is below the taxable threshold, the employer must compute the projected income, apply the correct regime, and document the nil TDS computation. Not computing TDS at all - rather than computing it as nil - is a compliance gap that triggers scrutiny during Form 24Q filing.

Mistake 5: Not issuing payslips or appointment letters. Both are mandatory under the Labour Codes. Every employee must have a written appointment letter (issued at joining) and a digital payslip (issued every month). Missing these documents are the first things an Inspector-cum-Facilitator checks during a SHRAM Suvidha inspection.

Penalties for Payroll Non-Compliance

Payroll non-compliance triggers penalties from multiple authorities simultaneously - Income Tax, EPFO, ESIC, State Labour, and Professional Tax. The compound effect can be devastating for startups.

How Payroll Connects with Other Business Functions

Payroll is not an isolated HR function - it connects directly with accounting (salary expense booking, TDS liability), banking (salary disbursement, statutory challans), compliance (PF/ESI/PT returns), and finance (cash flow planning for employer contributions). For startups, payroll is often the first compliance obligation that creates a paper trail with government authorities.

The salary structure you design at setup determines your employer cost for PF (12% of basic), ESI (3.25% of gross for eligible employees), and gratuity (4.81% of basic per year). A higher basic (to comply with the 50% rule) increases these costs. Budget for total employer cost = CTC + employer PF + employer ESI + gratuity provision - typically 15-20% above gross salary.

From a tax perspective, the employer's TDS computation must match the employee's actual income - including all salary components, perquisites, and deductions claimed. Errors in TDS computation create mismatches between Form 24Q and the employee's Form 16/Form 130, triggering notices from the Income Tax Department to both employer and employee.

Payroll Methods Compared: In-House vs CA-Managed vs Outsourced

Key Takeaways

Setting up payroll in India requires 6 registrations before the first salary: PAN, TAN, PF (at 20+ employees), ESI (at 10+ employees), Shops & Establishments, and Professional Tax (state-specific). Missing any registration creates retroactive liability from the date the obligation was triggered.

Salary structure must comply with the 50% basic rule under the Code on Wages 2019 from day one. Set basic + DA at 50-55% of gross, allocate HRA at 40-50% of basic, and use special allowance as the balancing figure. Designing a compliant structure at setup is far easier than restructuring later.

The monthly payroll cycle involves: salary computation by month-end, TDS deposit by the 7th, PF/ESI deposit by the 15th, Professional Tax per state schedule, payslip issuance by salary date, and digital record archival. Each deadline carries its own penalty for delay.

PF registration is the most commonly delayed obligation for startups. Once you cross 20 employees, back-contributions (with 12% interest and up to 100% damages) apply retroactively. The cost of delayed registration for 6 months can exceed Rs 5 lakh for a 25-person company.

For startups, payroll outsourcing or CA-managed payroll from day one prevents the compliance gaps that compound over months. The cost of professional payroll management (Rs 150-500 per employee per month) is a fraction of the penalty exposure from missed filings, incorrect TDS, or delayed PF registration.

Need Help Setting Up Payroll?

Setting up payroll for the first time in India involves navigating 6 registrations, designing a compliant salary structure, configuring 5 types of statutory deductions, and meeting 4 monthly filing deadlines - every month, without exception. Getting it right from day one prevents the compliance gaps that compound into lakhs of penalties.

Explore our payroll processing and management services for end-to-end payroll setup - from registration assistance and salary structure design to monthly payroll processing, statutory filing, record keeping, and ongoing compliance management.

For queries, reach out at +91 945 945 6700 or WhatsApp us directly.