For many global businesses looking to expand into India, analyzing salary taxes isn’t always on their radar as one of the most challenging aspects of doing business in India. Initially, it looks like a simple enough system to navigate for an employee; however, once you dig into the details of an employer’s responsibilities with respect to payroll taxes, you will find that numerous complex components, including payroll obligations, reporting requirements, and employer-side liability – are not something most foreign companies have anticipated when they enter the Indian market.

To understand salary taxation in India from the Asanify perspective, it is essential to understand how tax mechanics will impact payroll compliance, hiring models, and risk mitigation for businesses that do not have a local entity in India. This guide will break out salary taxation by way of employer responsibilities and execution process as opposed to just looking at it as a “personal finance” matter from the employee’s perspective.

How Salary Taxes Work in India

India follows a source-based taxation system, which means income earned for services rendered in India is taxable in India, regardless of where the employer is headquartered. For employers, this makes salary taxation inseparable from payroll operations and labour law compliance.

Under Indian tax law, “salary” is broadly defined and includes not only fixed pay but also variable components, benefits, and certain reimbursements. This broad definition is where many global employers miscalculate actual employment costs.

Another important distinction is how compensation is structured and communicated. In India, salary discussions often revolve around Cost to Company (CTC) rather than just gross or take-home pay. CTC includes all employer costs, fixed pay, bonuses, statutory contributions, and benefits, while take-home pay reflects what the employee receives after taxes and deductions. For companies unfamiliar with this structure, budgeting errors are common.

Crucially, employers play an active role in salary tax collection. Under Indian labour laws, employers are responsible for calculating, deducting, depositing, and reporting income tax on salaries. This makes payroll compliance a legal obligation, not an optional administrative task.

Components of Salary Subject to Tax

Most components of an employee’s salary in India are taxable unless explicitly exempted. Basic pay forms the foundation and is fully taxable. House Rent Allowance, bonuses, special allowances, and performance-linked incentives are also taxable, subject to specific exemption rules in certain cases.

Beyond cash compensation, Indian tax law includes perquisites and taxable benefits within salary income. These can include company-provided accommodation, vehicles, or other benefits that are valued and taxed according to prescribed rules. Misclassifying these benefits or ignoring valuation norms can lead to under-deduction of tax and employer exposure during audits.

For startups and global companies offering equity, ESOP taxation adds another layer of complexity. ESOPs in India are typically taxed at the time of exercise as a perquisite, with capital gains tax applicable at sale. Employers must factor this into payroll reporting and employee communication, particularly when hiring senior talent.

Employer’s Role in Salary Tax Compliance

In India, salary tax compliance is enforced through a withholding mechanism. Employers are required to deduct Tax Deducted at Source (TDS) every month based on projected annual income and applicable tax slabs. This is not a flat deduction; it requires continuous recalculation as salaries, bonuses, or declarations change.

At the end of the financial year, employers must issue Form 16 to employees. This document summarises salary paid and taxes deducted and is a critical record for employee tax filings. Errors in Form 16 often trigger employee dissatisfaction and compliance queries.

Employers are also responsible for quarterly and annual filings, reconciliations, and responding to payroll audits or tax notices. For foreign companies, this is where salary taxation intersects directly with payroll compliance risk. Any mismatch between salary paid, tax deducted, and tax deposited is treated as an employer failure, not an employee one.

Income Tax Slabs in India (Old vs New Regime – 2026)

India currently operates two parallel income tax regimes: the old regime and the new regime. While the choice is technically exercised by employees, the implications of each regime significantly affect employers, especially in payroll design and administration.

For 2026, global employers need to understand not just the slab rates, but how each regime impacts benefits structuring, payroll processing effort, and overall compensation cost.

Old Tax Regime – Deductions & Exemptions

The old tax regime allows employees to reduce taxable income through deductions and exemptions such as Section 80C investments, health insurance under Section 80D, House Rent Allowance, and Leave Travel Allowance.

From an employer perspective, this regime introduces higher payroll complexity. Payroll teams must collect declarations, verify proofs, apply exemptions correctly, and adjust TDS calculations throughout the year. While this regime can be tax-efficient for employees, it increases administrative effort and the risk of errors.

For global employers unfamiliar with Indian payroll practices, managing these exemptions internally can be challenging without strong local expertise.

New Tax Regime – Simplicity vs Flexibility

The new tax regime offers lower tax rates but removes most deductions and exemptions. While employees may pay more tax in some cases, the regime significantly simplifies payroll processing.

For employers, the new regime reduces dependency on proof collection, minimises mid-year payroll adjustments, and improves predictability of tax deductions. This simplicity is particularly attractive for global teams where standardisation and compliance consistency matter more than individual tax optimisation.

As more companies prioritise operational clarity and lower compliance risk in 2026, the new tax regime is increasingly aligned with global payroll best practices, especially for distributed and cross-border teams.

Salary Tax Deductions Employers Must Manage

For global employers, salary tax deductions in India are often misunderstood as employee-level obligations. In reality, most deductions are employer-managed risk areas governed by labour laws in India. Employers are responsible not only for calculating and deducting these amounts, but also for depositing them accurately and on time. Any lapse is treated as a compliance failure by the employer, regardless of whether the employee benefited from the deduction.

The most critical deduction is Tax Deducted at Source (TDS). Employers must estimate each employee’s annual taxable income, apply the correct tax regime, and deduct tax monthly. This process is dynamic, requiring recalculations when compensation changes, bonuses are paid, or declarations are updated. Errors in TDS deduction can lead to interest, penalties, and reconciliation issues during audits.

Beyond income tax, employers must also account for state-level and social security–style deductions. These obligations vary based on location, salary structure, and employee category. For companies hiring employees in India without deep local expertise, these deductions often become the first point of regulatory exposure.

Provident Fund (PF) and ESIC Contributions

The Provident Fund and Employee State Insurance are both aspects of social security that must be contributed to by employers under Indian labour laws. In addition to PF, which is based on an employee having a certain level of income (generally below a set limit), there are also many employers who voluntarily contribute to a PF account for their employees that earn over the income threshold. 

Employers will automatically contribute to ESIC accounts for employees who are below the required salary cap in order for them to receive advantages related to medical and social security. Employers and employees both contribute to PF and ESIC contributions. When employers are calculating how much they should contribute, as well as how much an employee’s share should be deducted from their salary, the employer must also include what they will pay into their ESIC account and then deposit that amount into that account by law, within the required timeframe. 

Failure to make timely payments or to accurately calculate an employee’s contribution will result in a penalty and continued failure to comply may result in an inspection. Many foreign companies do not take PF and ESIC contributions into account when calculating costs. Although PF and ESIC contributions are included as part of an employee’s CTC (Cost to Company), they are an important item to consider when developing a payroll budget for compensation packages in India.

Professional Tax Across Indian States

Professional tax is a state-level levy, and its applicability varies widely across India. Some states impose monthly deductions with income-based slabs, while others apply flat amounts or have no professional tax at all. This fragmentation creates compliance challenges for companies hiring across multiple locations.

The employer is responsible for deducting professional tax from employee salaries and remitting it to the appropriate state authority. Registration, filing frequencies, and payment deadlines differ by state. Foreign companies frequently underestimate this complexity, especially when employees work remotely from different regions.

Failure to manage professional tax correctly can result in fines and retrospective liabilities, making it a hidden but important risk area for global employers expanding in India.

Tax Optimization in India Through Salary Structuring

Tax optimization in India is not about aggressive avoidance or exploiting loopholes. For employers, it is about structuring salaries legally and thoughtfully to balance employee take-home pay with predictable employer costs.

India’s compensation landscape offers flexibility, but that flexibility comes with rules. Salary structures must align with tax regulations, labour laws, and payroll execution realities. Poor structuring often leads to higher tax outflows, employee dissatisfaction, or compliance corrections later.

For foreign firms, the challenge is navigating India-specific norms, such as CTC-based offers and allowance-heavy structures, without overcomplicating payroll or increasing audit risk.

Common Salary Structuring Techniques

• House Rent Allowance (HRA) vs fully taxable allowances: HRA, when structured correctly and supported by employee declarations, can reduce taxable income under the old tax regime. In contrast, special allowances are fully taxable but simpler to administer. Employers must balance tax efficiency with payroll complexity and documentation risk.

• Reimbursements and flexible benefit components: Certain reimbursements and flexible benefit plans can be structured within prescribed limits to improve employee take-home pay. These require clearly defined policies and disciplined payroll execution to avoid classification and audit issues.

• Performance-linked bonuses and variable pay: Variable components allow employers to align compensation with performance while controlling fixed salary costs. However, bonuses are fully taxable and must be accounted for correctly in TDS calculations when paid.

• ESOPs and startup equity compensation: ESOPs are commonly used to attract senior or high-growth talent. In India, they are taxed as a perquisite at the time of exercise, with capital gains tax applicable at sale. Employers must plan for payroll reporting and employee communication to prevent unexpected tax liabilities.

Salary Taxes for Foreign Companies Hiring in India

For foreign companies, salary taxation in India becomes significantly more complex when hiring without a local entity. While it may seem possible to “run payroll remotely” or rely on third-party processors, Indian tax and labour frameworks are not designed for informal or proxy arrangements. Salary taxes are tightly linked to employer identity, place of work, and regulatory accountability.

One of the biggest risks is legal exposure from operating payroll without a recognised employer presence. Indian authorities assess not just whether taxes were paid, but who paid them and under what legal authority. When a foreign company directly controls employees in India without a compliant structure, salary taxation can trigger broader regulatory scrutiny.

Another concern is Permanent Establishment (PE) risk. Running payroll, supervising employees, or making employment decisions in India can strengthen the argument that a foreign company has created a taxable presence. Once PE is established, corporate tax exposure follows, often retroactively.

Payroll misclassification is a related issue. Many companies attempt to engage Indian workers as contractors while managing them like employees. From a salary tax perspective, this often results in under-deduction of tax, incorrect benefit treatment, and disputes over employment status. For companies trying to build teams in India quickly, these shortcuts create long-term risk.

Risks of Managing Indian Payroll Without Local Expertise

Managing Indian payroll without deep local expertise frequently leads to compounding issues. Penalties for late or incorrect tax deposits accumulate quickly, and payroll audits are becoming more common. Employee disputes, especially around tax deductions, Form 16 errors, or benefit eligibility, often surface months later, when corrections are harder and more expensive.

Non-compliance with labour laws in India further amplifies these risks. Salary tax compliance does not exist in isolation; it intersects with PF, ESIC, professional tax, and termination rules. Without local knowledge, foreign employers often remain compliant in one area while violating another, exposing themselves to avoidable regulatory action.

Managing Salary Taxes Through an Employer of Record (EOR) in India

For global companies, Employer of Record models have emerged as the most practical way to manage salary taxes in India without assuming unnecessary risk. Rather than patching together payroll tools and advisors, EORs provide a single, compliant employment framework.

An Employer of Record in India becomes the legal employer of the workforce. This means salary tax calculation, deduction, and filing are handled under a locally compliant entity, while the client company retains full operational control over the employee’s work. The separation of legal responsibility and day-to-day management is what makes EORs particularly effective for international hiring.

Under this model, payroll, tax compliance, and labour law obligations are not outsourced piecemeal, they are structurally owned by the EOR. For foreign employers, this significantly reduces the risk of errors, disputes, and regulatory exposure while accelerating hiring timelines.

What an EOR Handles vs What the Client Controls

In an EOR arrangement, the provider takes ownership of salary tax computation, monthly deductions, statutory filings, and annual reporting. This includes managing changes in tax regimes, bonuses, and variable pay in line with Indian regulations. Statutory benefits and labour law compliance are also handled end to end.

The client company, meanwhile, controls role definition, performance management, compensation decisions, and business priorities. This balance allows companies to operate as if the team were internal, without bearing the legal burden of employment.

For finance and HR leaders, this clarity around responsibility is often the deciding factor.

Employer of Record Services Cost vs In-House Payroll

From a cost perspective, EOR models offer predictability that in-house payroll setups often lack. Employer of Record services cost is typically structured as a clear monthly fee layered over actual employment expenses. There are fewer surprise costs tied to penalties, advisors, or corrective filings.

In contrast, running payroll in-house without local infrastructure often appears cheaper initially but becomes expensive once compliance gaps emerge. Beyond cost, EORs reduce risk and enable faster market entry, allowing companies to hire in weeks rather than waiting months for incorporation and registrations.

For companies evaluating EOR providers in India, the value lies not just in payroll execution, but in risk insulation and operational speed.

Why Global Companies Choose Asanify for Salary Tax Compliance

Asanify is built for global companies that want confidence, not guesswork, when managing salary taxes in India. As a compliance-first EOR and payroll expert, Asanify combines deep India-specific knowledge with systems designed for cross-border teams.

What sets Asanify apart is its focus on end-to-end ownership. Salary tax compliance, statutory benefits, payroll processing, and labour law adherence are managed under one framework, reducing fragmentation and error risk. Pricing is transparent, allowing finance teams to forecast employment costs accurately.

For companies scaling operations or looking to build teams in India, Asanify provides the infrastructure to grow quickly while staying compliant, without requiring a local entity or complex internal setup.

Key Mistakes Global Employers Make With Salary Taxes in India

• Misclassifying employees as contractors: Treating long-term, fully managed workers as contractors often leads to underpayment of taxes and benefits, triggering penalties and disputes.
• Ignoring state-specific labour and tax laws: Salary taxes and deductions vary across Indian states. Applying a one-size-fits-all approach frequently results in compliance gaps.
• Underestimating payroll compliance complexity: Many employers focus only on income tax while overlooking PF, ESIC, professional tax, and reporting obligations, creating cumulative risk.
• Relying on fragmented advisors and tools: Using separate vendors for payroll, tax, and compliance increases the likelihood of errors and weak accountability.

Conclusion

Managing salary taxes in India is a key compliance responsibility for global companies looking to hire and build teams in India. With multiple tax regimes, mandatory payroll deductions, and evolving labour laws in India, employers must ensure accurate calculations and timely filings to avoid compliance risks.

For many HR leaders and founders, achieving tax optimization in India while remaining compliant can be challenging without local expertise. This is especially true for companies hiring without setting up an Indian entity, where payroll and tax errors can lead to penalties and delays.

Partnering with an experienced Employer of Record in India helps simplify this process. An EOR manages salary tax compliance, payroll processing, and statutory obligations, allowing companies to focus on growth while staying compliant.

With Asanify’s Employer of Record services, global businesses can hire confidently in India, maintain payroll accuracy, and scale efficiently—without the operational burden of managing salary taxes internally.

FAQs

How are salary taxes calculated in India for employees?
Salary taxes in India are calculated based on taxable income after deductions and exemptions, using either the old or new tax regime. Employers deduct tax at source (TDS) through payroll each month.

What taxes do employers need to deduct from salaries in India?
Employers must deduct income tax (TDS), provident fund (PF), professional tax (state-specific), and ESIC where applicable. These deductions are governed by Indian labour and tax laws.

Is TDS mandatory for foreign companies hiring in India?
Yes, TDS is mandatory even for foreign companies hiring employees in India. Employers are legally responsible for deducting and depositing taxes in compliance with Indian tax regulations.

What is the difference between old and new tax regime in India for salary?
The old tax regime allows deductions and exemptions like HRA and 80C, while the new regime offers lower tax rates with fewer deductions. Employees can choose the regime that results in lower tax liability.

How can companies achieve tax optimization in India legally?
Companies can achieve tax optimization in India through compliant salary structuring, benefits planning, and choosing the right tax regime. All strategies must align with Indian tax and labour laws.

Can I hire employees in India without setting up an entity?
Yes, companies can hire employees in India without a local entity by using an Employer of Record (EOR). The EOR acts as the legal employer and manages payroll and compliance.

What is the cost of using an Employer of Record in India?
The cost of using an Employer of Record in India typically includes a monthly per-employee fee. Pricing depends on services covered, employee count, and compliance scope.

Are salary taxes different when hiring through an EOR in India?
Salary tax rules remain the same, but an EOR ensures accurate calculation, deduction, and filing. This reduces compliance risk and simplifies payroll management for global employers.

Not to be considered as tax, legal, financial or HR advice. Regulations change over time so please consult a lawyer, accountant  or Labour Law  expert for specific guidance.