Payroll is the process of paying a company's employees' salaries. It begins with creating a list of employees who must be paid and concludes with the recording of those charges. It's a complicated procedure requiring collaboration across several departments such as payroll, HR, and finance. On the other hand, businesses may easily manage all of the complications by utilising current technology. To understand how the payroll system works, we first need to know about major components of payroll in India.
Did you know? The payroll system started with the Athenians and became popular with the industrial revolution in the 18th and 19th centuries.
What is payroll?
Simply payroll management means calculating what is owed to employees for a given payroll cycle after taking into account essential deductions such as TDS, employee PF contributions, meal coupons, and so on.
What is the Payroll process?
When someone mentions payroll or HR payroll, the first thing that comes to mind is making payments to employees. However, payroll is more than merely entering new employees into the payroll system and paying them on payday. It aids in recording and maintaining work compensation, income tax and relevant details. As a result, understanding the payroll system and its administration is critical for every firm. Any inconsistencies in payroll activities might erode your employees' trust and productivity.
For efficient payroll management, startups, small, medium, and big organisations must thoroughly understand payroll processing. The entire amount of salaries paid by the company to its employees and other workers such as contractors and freelancers are referred to as payroll. Many factors are evaluated during processing, and data from other departments such as HR and accounting is also required. Employee payment estimates are based on productivity, employee benefits, and regular and statutory deductions in the payroll process. Every business does it regularly. Payroll is usually done once a month, twice a month, once a week, or twice a week. Payroll calculation differs from one organisation to the next, depending on the payroll structure, which has several components.
Components of payrolls in India
Lets us look at various components of payrolls in India
1. Employee Information
The first stage in payroll is to gather all relevant information regarding your employee's financial situation. Before an employee may be fully onboarded, they must complete the necessary paperwork required by governing laws and corporate standards. In addition to attendance data, working hours, and mid-year wage adjustment data, some firms track various other factors. This information must be gathered and digitised for safe preservation.
2. Payroll policy
- To guarantee that the payroll department runs efficiently and that employees are paid accurately, and on time, a business must set payroll policies and processes. As a result, it is critical to sustaining employee morale and financial stability.
- The policies' procedures ensure a well-defined approval process, efficient payroll activities, the availability of forms, and proper controls.
- A payroll policy explains the payroll process, which includes the administration of an organisation's employees' salaries, timekeeping, payroll schedules, and payment methods. This policy is intended to establish control and inform employees on what to expect on payday.
3. Basic Salary
The basic pay, which is the base pay that remains constant during an employee's term at the firm, can range from 35% to 65% of the total CTC. A variety of things influences the basic pay. The primary one is the employee's title and position in the hierarchy. Additional responsibility and fixed commissions are secondary issues. This sum is completely taxed.
An allowance is a monetary advantage the employer provides to the employee and their regular income. These advantages are provided to compensate for any costs incurred to complete the service. Salary allowances are divided into three groups: taxable, non-taxable, and partially taxable allowances.
- Allowance for Dearness (DA): Dearness Allowance (DA) is a cost-of-living adjustment allowance given to employees to help them cope with inflation. Employees' DA is fully taxable together with their salary.
- Allowance for Entertainment (EA): Employees are entitled to the lower declared amount, one-fifth of their basic income, real allowance received, or ₹5,000. This is a stipend given to staff to reimburse them for expenses related to client hospitality. On the other hand, employees of the government can seek an exemption in accordance with section 16 (ii). It is subject to taxation for all other employees.
- Allowance for Overtime: Employers may pay overtime to employees who work beyond their regular working hours. This is referred to as overtime, and any compensation received for it is completely taxable.
B. Allowances That Are Only Partially Taxable
- Allowance for House Rent (HRA): House rental allowance (HRA) is a stipend for paying rent on a home. HRA based on actuals received by the employee rent paid based on actuals less than 10% of basic pay. In metros, such as Delhi, Mumbai, Chennai, or Kolkata, as much as 50% of basic pay income, or 40% if the housing is in a non-metro. After claiming the deduction, any House Rent Allowance received is taxable.
- Conveyance Allowance (CA): CA is sometimes known as Transport Allowance. This is money paid by the firm to cover the expense of travel from home to work and back, and it is tax-free. Employees are typically given allowances on top of their basic wage, which may or may not be taxable under the Income Tax Act.
- Allowance for Education: In India, employees are paid a set amount to spend on their children's education. The maximum amount that can be claimed for the education fee is ₹1.5 lakh in a financial year.
- Allowance for Medical Treatment: When an employee or a member of his/her family becomes ill, the company pays a stipend to cover their treatment costs. If the amount of such reimbursement exceeds ₹15,000 per year, it is taxable.
C. Non-taxable Benefits
Some allowances paid to government employees, judges, and other officials are not taxed. These are the following:
- Allowances paid to government employees in other countries: When the government of India employees are awarded an allowance while serving abroad, that income is tax-free.
- Judges' allowances in the Supreme Court and the High Court are not taxable.
Wages withdrawals from an employee's total earnings to pay taxes and perks such as health insurance are payroll deductions. Some payroll deductions are optional and can be deducted from a paycheck on a pre-tax or post-tax basis if the employee gives written consent. On the other hand, employers who fail to fulfil tax deductions appropriately may be held accountable.
Also read: How to do Payroll Management in Tally ERP 9
6. Salary in Gross
Every month, this is an employee's salary before deductions. This is known as the CTC or Cost to the Company, and it is calculated every year.
All of the other components are often cut from the gross salary, for example:
- Conveyance costs (common recurring deductions),
- Professional Tax (PT),
- Provident Fund (PF),
- Employee State Insurance (ESI).
Employers frequently pay their employees' PF in addition to what is deducted from their gross salary. PT and PF are government deductions that are required (depending on the company's size) based on the employee's pay grade. Aside from PF, employees can contribute to the Voluntary Provident Fund (VPF) or the Public Provident Fund (PPF), providing tax benefits. Employees at ESI have access to medical benefits, including paid medical leave.
7. Net salary
Employees' net salary is what remains after these deductions. In India, net salary consists of the following elements:
1. Governmental deductions:
- Professional Tax (PT)
- Provident Fund (PF)
- Employee State Insurance (ESI)
- Voluntary Provident Fund (VPF) or Public Provident Fund (PPF)
2. Other elements include:
- Basic salary
- Housing Allowance for Rent (HRA)
- Dearness Allowance (DA) - Dependent on where you work.
- Allowance for transportation
- Exceptional treatment
- Allowance for food
- Allowance for Travel While on Leave (LTA)
- Exemption for all
- Education Allowance for Children
- Allowance for mobile phones and telephones
- Allowance for fuel (apart from a travel allowance, in certain cases)
- Allowance for car maintenance
- Fund for the Welfare of Workers
Depending on the company's policy, some of these net pay components are flexible-benefit options that employees can choose annually, half-yearly, or quarterly. These flexible-benefit choices allow employees to choose a percentage of their compensation that will be tax-free. The components of net pay are paid regardless of who is responsible for them.
8. Ad hoc payment
Annual bonuses, incentives (based on performance), festival advance (some employers give quarterly deductions – monthly before a major festival season), or departure encashment are examples of one-time or occasional income. Companies also provide salary/wage advances on a request basis, referred to as ad-hoc compensation.
9. Tax Deducted At Source
TDS (Tax Deducted At Source) is a direct taxation system that applies to various income classes. When an employee's salary exceeds the tax-free threshold, it is deducted from their pay. Allowances like HRA, travel, leave travel, children's education, and medical, among other things, impact the TDS deduction. Other deductions, such as caring for disabled children and parents, and interest on home loans, reduce employees' net earnings.
Perquisites are benefits that an employee receives in addition to their income. Depending on the nature of the fringe benefits or perquisites, they may be taxable or non-taxable. A variety of advantages are provided in addition to a person's compensation and are classified as fringe benefits or perks. These components are taxed separately from the employer's account to promote transparency and accountability. Amenities provided by the company to employees are classified as perquisites and are subject to taxation according to the rules and regulations in place.
Perquisites can be classed into one of three categories depending on their tax.
1. Perquisites that are taxable
Rent-free housing, the supply of gas, water, and electricity, the employee's professional tax, reimbursement of medical expenses, and the income of a servant engaged by the employee are all examples of taxable benefits. Any other fringe benefit supplied by the employer to employees, such as free meals, gifts over Rs.5,000, club and gym memberships, and so on, are taxable perquisites.
2. Perquisites Exempted
Travel allowance, computer or laptop provided by the company for official use, refreshment provided by the employer during office hours, medical aid, use of health club, sports club, telephone lines, interest-free salary loan provided by the employer to employees, employer contribution to provident fund, free medical and recreational facilities, and so on are examples of non-taxable fringe benefits.
3. Employees exclusively tax perquisites
This category comprises company-owned cars utilised by employees, educational facilities for children, and domestic servant services, among other things.
Payroll processing is the process of determining an employee's 'net pay' after specifying their wage structures, components, deductions, and allowances and establishing the necessary regulations for taxes and other changes. Components of payroll can be a difficult procedure for businesses. Several rules and regulations must be followed. Payroll also necessitates cross-channel coordination among many departments. As a result, it's critical to stay on top of all payroll components and how they affect an employee's pay.
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