5 Payroll Compliance Mistakes US Companies Make When Hiring in India

Indian payroll looks familiar until it isn't. There's income tax withholding, social security, and a payslip, so far so normal.

Then you find that the social security contribution has a wage ceiling, splits three ways, and stops applying above a threshold. That professional tax is set by the state, not the country. And that when someone resigns, you may have two working days to pay them everything they're owed.

Here are the five that cause the most trouble.

Mistake 1: getting Provident Fund wrong

The Employees' Provident Fund is India's main retirement scheme. It applies to establishments with 20 or more employees.

The headline is simple: 12% from the employee, 12% from the employer. The complication is what happens to the employer's 12%.

So the employer's real cost isn't 12%. It's 12% plus 0.50% for the deposit-linked insurance scheme plus 0.50% administrative charges, a minimum of ₹500 a month.

The wage ceiling is ₹15,000 a month of basic pay plus dearness allowance. Above that, mandatory contribution is calculated on the ceiling, though many employers contribute on full salary voluntarily, and once you start you generally can't stop.

Mistake 2: assuming ESI works like PF

Employees' State Insurance is the health and disability scheme. Different rates, different ceiling, different threshold.

EPFO and ESIC contribution schedules. The ESI applicability threshold is extended by state notification to different sectors, confirm the rule for your specific state before assuming it applies or doesn't.

The threshold difference matters. A company with 12 employees in India may be outside PF but inside ESI. Plenty of employers register for one and not the other.

And unlike PF, ESI stops applying to an employee once their wages exceed ₹21,000 a month, but only from the start of the next contribution period, not immediately.

Mistake 3: treating a contractor as a contractor

This is the expensive one.

India has no single statutory test for employment status. Courts apply several overlapping tests, developed over decades of case law.

If a court or authority finds an employment relationship, the consequences run backwards: unpaid PF and ESI contributions for the whole period, plus interest and damages, plus gratuity and leave entitlements the person should have accrued.

The practical signal is simple. If someone works only for you, on your schedule, using your systems, doing work that's core to your business, calling them a contractor is a label, not a legal position.

Mistake 4: assuming India has one set of rules

It doesn't. Several things vary state by state.

Professional tax

Levied by state, not centrally. Some states don't have it. Those that do set their own slabs, and most cap the annual amount at around ₹2,400 to ₹2,500.

State commercial tax department schedules, 2026. Slabs are amended periodically by state legislation, verify the current rate for your state before running payroll.

Minimum wage

Set by state and by skill category, and often by zone within a state. Delhi's unskilled minimum was ₹18,456 a month from April 2025. Maharashtra's ranges from about ₹12,728 depending on zone. Karnataka's runs from ₹19,319 to ₹31,114 depending on zone and skill level.

Shops and establishments

Every state has its own Act governing working hours, leave and registration. Your Bangalore employee and your Mumbai employee are covered by different statutes.

Mistake 5: not knowing about the two-day rule

Under Section 17(2) of the Code on Wages, 2019, wages payable on termination must be paid within two working days of removal, dismissal, retrenchment or resignation.

Two working days. Not the 45 to 60 days that was common informal practice.

If your final settlement process runs on a monthly cycle, it does not meet this standard.

This is part of the wider Labour Codes reform, which brings us to the thing every employer hiring in India should be tracking.

The Labour Codes: where things actually stand

India consolidated 29 labour laws into four Codes. Their status has changed repeatedly, and a lot of published guidance is out of date.

The change that will move your costs

Buried in the Code on Wages is a new definition of "wages." At least 50% of total compensation must be classified as wages, basic pay plus dearness allowance.

This closes a long-standing practice of keeping basic pay low, often 25–40% of total cost, and loading the rest into allowances. Because PF and gratuity are calculated on basic pay, a low basic meant low statutory cost.

The effect: higher PF contributions, higher gratuity liability, and lower take-home pay for the employee unless you regrade. If you're budgeting Indian headcount for 2027, model this.

The other things worth knowing

• Gratuity is payable after five years of continuous service, at 15 days' pay per year, calculated as basic plus dearness allowance × 15 ÷ 26. The tax-free cap for private sector employees is ₹20 lakh.
• Fixed-term employees now qualify for gratuity on completing their contract term, even under five years.
• TDS on salary under Section 192 is due by the 7th of the following month, with Q4 extended to 30 April.
• Maternity leave is 26 weeks under the Maternity Benefit Act.

The takeaway

Key takeaways

• PF and ESI have different rates, different ceilings and different headcount thresholds. Registering for one doesn't cover the other.
• The employer's PF cost is 13%, not 12%. The extra 1% is insurance and administrative charges.
• Contractor misclassification is judged on five overlapping tests, and the consequences run backwards for the whole engagement.
• Professional tax, minimum wage and shops-and-establishments rules all vary by state.
• Final settlement is due within two working days under the Code on Wages. Monthly settlement cycles do not comply.

Sources

1. Employees' Provident Fund Organisation. Contribution rate schedule. https://www.epfindia.gov.in/site_docs/PDFs/MiscPDFs/ContributionRate.pdf

2. Code on Wages, 2019. Section 17, time limit for payment of wages. https://www.advocatekhoj.com/library/bareacts/codeonwages/17.php

3. KPMG. Flash Alert 2026-127, India Labour Codes and Central Rules. https://kpmg.com/xx/en/our-insights/gms-flash-alert/2026/flash-alert-2026-127.html

4. DLA Piper. Key considerations of the notified Central Rules under India's Labour Codes. https://knowledge.dlapiper.com/dlapiperknowledge/globalemploymentlatestdevelopments/2026/Key-considerations-of-the-notified-Central-Rules-under-Indias-Labour-Codes

5. India Briefing. Guide to minimum wages in India. https://www.india-briefing.com/news/guide-minimum-wage-india-19406.html/

Indian labour law is changing quickly and the Labour Codes are being implemented state by state. Every figure and rule here should be confirmed against the Ministry of Labour and Employment or the relevant state authority before you act on it. This is a general overview, not legal advice.