Payroll compliance is important for employee satisfaction and organizational stability. Paying employees correctly and on time helps build trust and also ensures compliance with statutory requirements. However, you should not think that payroll is only about salary transfers; it also involves staying compliant with legal requirements, including those of taxation, social security, employee benefits, and labor welfare. These regulations are collectively known as payroll compliance laws. Also, failure to adhere to them can result in heavy penalties, legal disputes, and reputational damage. Especially for employers, understanding and maintaining payroll compliance is important for risk management and smooth business operations. Having said that, in this blog, let us discuss the key payroll compliance laws every employer must follow. Scroll down for more information.
What is Payroll Compliance?
Payroll compliance is simply the act of complying with all statutory obligations regarding employee remuneration, which includes calculating salaries, paying salaries, deducting taxes, contributing to social security schemes (where applicable), as well as filing the returns mandated by statutory organizations, accurately and on time. If we look specifically at India, a large number of obligations/regulations exist, including the Income Tax regulations, Employees’ Provident Fund (EPF), Employees’ State Insurance (ESI), Professional Tax, Payment of Bonus Act, Payment of Gratuity Act, Labour Welfare Fund, etc. As such, payroll compliance is not an option anymore; it is a legal requirement. It doesn’t matter whether you’re a start-up, mid-sized, big, or multinational company; all companies have to comply with their statutory obligations or face penalties, legal issues, and audits. Also, non-compliance can adversely affect the company’s reputation, and employees may lose faith in your organization.
1. Income Tax Act – TDS on Salaries
The Income Tax Act outlines the rules for deducting income tax from employees’ salaries. The Tax Deducted at Source (TDS) system is the means of deducting tax from an employee’s salary while paying it out to them. The employer must deduct tax from the employee’s salary, amount declared towards investments, or claim exemptions in sections such as 80C, 80D, etc. The tax amount deducted must be deposited with the government in accordance with the deadlines specified, and the employer is also required to issue Form 16 to the employee as evidence of the deduction made. Failing to comply with its rules regarding TDS will cause penalties, interest, or tax expenses to be disallowed. Adhering to TDS obligations promotes transparency, compliance, and smooth filing of employee income tax returns.
2. Employees’ Provident Fund (EPF) Act, 1952
The Employees’ Provident Fund (EPF) is one of the most significant payroll compliance requirements applicable in India. EPF is governed by the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952, and consists of contributions by the employer and employee to a fund for retirement savings. EPF is typically calculated based on 12% of the basic salary and dearness allowance, of which both the employer and employee contribute 12%. Employers have the responsibility of deducting the employee share, contributing their own, and depositing the amount to the EPF authorities promptly. EPF provides long-term financial security to the employee and is an obligatory requirement by organizations meeting a specified number of employees (typically 20). Failure to comply with EPF requirements could leave the employer liable for penalties, interest, and prosecution.
3. Employees’ State Insurance (ESI) Act, 1948
The Employees’ State Insurance scheme (ESI) provides medical, sickness, maternity, and disability benefits to employees whose salary/income does not exceed the prescribed wage limit. The ESI scheme is regulated by the Employees’ State Insurance Act, 1948, which mandates employers and employees to contribute to the Employees’ State Insurance Fund. There is a stipulated percentage amount that employers have to contribute (3.25%) and employees have to contribute (0.75%). Employers are responsible for: (a) registering eligible employees and their dependants promptly; (b) ensuring that contributions are appropriately calculated; and (c) remitting contributions promptly to ESIC. Failure to comply with the requirements will have a negative impact on eligible employees’ access to medical and insurance benefits, and potential penalties and damages under the respective law.
4. Professional Tax
Professional tax operates at the state level and only in certain Indian states (for example, Maharashtra, Karnataka, and West Bengal). Employers must deduct this tax from employees’ salaries and send it to the state government. The amount you are required to deduct is hostage to the rate established by the state and the income slab of the employee. Since it is a state subject, there are differences in the compliance process from state to state, and employers with multiple locations in different states must be thoughtful. Do not underestimate the importance of compliance – this is a small amount compared to other payroll deductions, and equally important nonetheless.
5. Payment of Bonus Act, 1965
The Payment of Bonus Act, 1965, requires employers to pay an annual bonus to their employees if the employee earns a wage that meets, and does not exceed, a given wage ceiling. The bonus is calculated based on profits or productivity and ranges from 8.33% to 20% of the employee’s wages. Employers should then be responsible for ensuring that eligible employees receive their bonuses within the timeframes required. Failure to comply would likely leave employees dissatisfied and may cause employees to take action against the employer, as bonuses under this law are a statutory right. The Act fulfills the purpose of enabling profit-sharing as part of a fair approach to employee benefits while simultaneously galvanizing and motivating employees.
6. Payment of Gratuity Act, 1972
The Payment of Gratuity Act, 1972, ensures that employees who have completed five years in a company receive lump-sum payments for their continuous service. Always remember that gratuity is payable upon retirement, resignation, death, or disability. Also, it is calculated according to the last drawn salary and years of service. However, employers must give timely payment of gratuity to eligible employees. Remember, non-compliance attracts both penalties and disputes between employees, along with intervention by labor courts. Moreover, gratuity is a kind of token of appreciation by the employer to the employee for long-term service. This is why gratuity plays an important role in employee retention.
7. Labour Welfare Fund (LWF)
The Labour Welfare Fund (LWF) is another state-level compliance requirement, which is applicable in certain states of India. Under this, both employers and employees contribute nominal amounts to this fund, which is used for employee welfare programs, including housing, healthcare, and education. In this, employers are responsible for deducting employee contributions, adding their share, and submitting the total to the state welfare board. Again, non-compliance can result in penalties and disqualification from the government welfare benefits. Remember, this small amount can have a significant impact on employee welfare.
8. Shops and Establishments Act
The Shops and Establishments Act governs working conditions, hours of work, leave policies, and wage payments at the state level. Adhering to this act ensures that employees are provided with statutory holidays, overtime pay, and proper working conditions. Employers must register under the act, maintain records, and adhere to prescribed rules because non-compliance can lead to fines, inspections, and even closure of operations in severe cases. Also, the act protects the interests of employees working in retail shops, offices, and commercial establishments.
9. Maternity Benefit Act, 1961
Through the Maternity Benefit Act, 1961, a woman employee has the right to maternity leave and benefits post pregnancy/childbirth. Employers are required to provide paid maternity leave for up to 26 weeks and other entitlements such as nursing breaks. Failure to comply can result in legal action, negative staff morale, and a loss of reputation. To comply with the law also means creating an environment that is supportive of its employees.
Conclusion
Payroll compliance is designed to protect the interests of employees, maintain accountability, and ensure fair compensation. From TDS and provident funds to gratuity and maternity benefits, each rule and regulation has a purpose, i.e., to promote financial stability and welfare. For employers, compliance is more than just about fulfilling a legal requirement; it is also about minimizing the risk of legal disputes, financial penalties, and reputational harm. By staying compliant with the evolving tax rules and regulations, companies can deal with the complexities of payroll compliance with ease. Lastly, payroll compliance is not a burden; instead, it is an investment in stability, long-term success, and trust. Employers who focus on compliance are better able to grow their business, where both employee and employer thrive.