Payroll may appear to be a mundane and procedural service with functions largely occurring out of the employee’s sight, but payroll is the core of the employment contract. Each time a payslip is issued it comes with an implied assurance that an individual’s time, effort, and commitment are acknowledged and respected.
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Payroll calculation is more than just nominal figures. It involves various pay scales, tax regimes, legal deductions, and legal requirements. Mistakes can cause dissatisfaction, non-compliance, and even legal implications.
This guide takes you to how to tackle payroll accuracy systematically, especially for the HR teams of the future.
What is Payroll Calculation?
Payroll calculation is the step-by-step procedure of computing an employee’s pay after adjusting the earnings for additions, deductions, and taxes. It affirms the gross salary, mandatory deductions like the PF and Professional Tax, and the other optional deductions are calculated before releasing the net pay.
Indian payroll also has to conform to labor laws like:
- The Payment of Wages Act, 1936
- The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
- The Employees’ State Insurance Act, 1948
- Income Tax Act, 1961
Defects of any of these would mean compliance concerns and penalties.
How is Payroll Calculated? A Step-by-Step Guide
Payroll processing involves the following stages that need to be executed carefully, and all compliance rules must be observed strictly:
1. Gather and confirm employee data
- Obtaining current employee data is the first step:
- PAN and Aadhaar details
- Salary structure (fixed and variable components)
- Bank account information
- Benefits enrolments and tax declarations (Form 12BB)
Misinformation may result in wrong calculations, wrong filing of taxes, or salary disbursement mishaps. In larger organizations, even if there is one PAN update missing, it could delay the salary credit for hundreds of people.
It is evident from a PwC report that nearly 75% of organizations are now using automated payroll tools to ensure that employees’ information is correct and not influenced by manual errors. Quarterly auditing of the employee master data is a wise approach to prevent such payroll issues.
2. Define and Calculate Gross Salary
Total pay before taxes is known as the gross salary. Typically, it consists of:
- Basic salary
- House Rent Allowance (HRA)
- Special Allowances
- Performance bonuses
- Other reimbursements (conveyance or medical)
The above components should be categorized accurately as they come with tax implications. For instance, special allowances come fully taxable, whereas HRA is liable for tax exemptions if rent receipts are submitted.
A KPMG report says that 47% of HR professionals have suffered penalties due to wrong salary calculations which influences income tax computation and deductions. While developing the CTC structures for employees, HR should also consider tax optimization, especially for mid-level earners.
3. Determine Statutory Deductions
Following gross pay, make the necessary deductions required by Indian labor laws:
| Deduction Component | Rate |
|---|
| Provident Fund (PF) | 12% of basic salary (employee share) |
| Employee State Insurance (ESI) | 0.75% of gross (employee share if eligible) |
| Professional Tax | Based on respective state laws |
| Income Tax (TDS) | As per applicable income tax slabs |
That is why being aware of the current tax regulations is very important. For instance, professional tax in Maharashtra is charged according to slabs and differs among employees in the same organization.
According to the Workforce Institute, 60% of employees would like to leave the organization after two payroll errors, which shows how significant compliance is for retention. Specifically, statutory deductions are also company liabilities, which implies that employers have to remit and deposit their part of the PF contributions promptly.
4. Apply Voluntary Deductions
It is also common for employers to allow extra deductions which are done by the agreement of the employee as follows:
- Loan EMIs
- Voluntary Provident Fund contributions
- Group insurance premiums
- Meal card contributions
- Donations (if opted through payroll)
These deductions must always be authorized by the employees to prevent cases of disagreement. Conduct electronic consents of voluntary deductions and provide employees with options to view them through ESS.
Modern HRMSs include features that check for voluntary deductions that have been realized or computed to exceed the gross salary of an employee to eliminate negative pay.
5. Calculate Net Salary
Lastly, use a simple formula to determine the net salary:
Net Salary = Gross Salary – (Statutory Deductions + Voluntary Deductions)
Although the formula is simple, it means checking deduction caps. For instance, PF cannot go beyond the statutory limit, although the employee has the option to go for more than the limit.
The payslips produced by companies should include detailed information on all the gross and net calculations so that everyone can check how it is done. They also assist the employees in handling income tax issues and their annual return filing.
This increases Payroll compliance and employee satisfaction, which is a direct attribute to high pay-related engagement rates, according to SHRM.
6. Disburse Salaries Timely
After such calculations are done, salaries should be disbursed through a genuine banking system. According to the rules of the Payment of Wages Act, of 1936, wages must be paid within seven days of a wage period.
Most organizations in India prefer to pay salaries within the last week of the month with 28, 29, 30, or 31 being the most common dates.
Outsourcing agencies or in-house finance departments have to ensure that all the bank transfer files are encrypted and authorized to avoid cyber risks. There has been a decline in manual work due to integration between the payroll software and banking APIs, making payout much more accurate.
7. Conduct Regular Payroll Compliance Audits
Payroll is not limited to just processing the salary of the employees. Internal audits should be conducted periodically to enable,
- The statutory remittances, such as PF, ESI, and TDS were paid accurately and on time.
- No discrepancies between the pay slips and government filings are observed.
- Bonus and gratuities are appropriately accrued.
- The submission of the Year-end Form 16s and TDS filed matches the compensation paid to employees.
According to the Gartner report, people who do a biannual payroll audit have been able to reduce their tax notice and compliance penalty by 35%.
The Future Payroll is Smart & Employee-First
Essentials of Payroll processing are changing, it is no longer just a back-office routine or clerical function, but a smart approach towards the employees. Since digitalization is on the rise, compliance with regulations and consideration of the employees are shaping how payroll is going to be the basis of creating or maintaining loyalty. Payroll calculation is thus an indisputable training function to develop the workforce that can meet the needs of the future.