Understanding tax implications is key if you hire employees or run a business in India.

Several things can go wrong if you’re not thorough with every tax implication in India. 

You must deal with issues such as penalties, missed filings, compliance problems, and even financial losses.

In this blog, you will learn how taxes affect employers, employees, and everyday business operations. 

We’ll also explain how an Employer of Record (EOR) can make tax compliance easier.

Here’s what we’ll cover:

• • Major tax implications for employees in India
  • Major tax implications for employers in India
  • How an EOR handles payroll and tax implications
  • How does an EOR help manage tax implications effectively by reducing compliance risks?

By the end, you’ll know exactly what your tax responsibilities are and how to simplify the process.

What Are the Tax Implications in India for Employees? 

Your employee’s taxes depend on which system they choose. The new regime is now the default. It has lower rates but takes away most deductions. 

The old regime gives employees more room for tax savings (like HRA, 80C, home loan interest) but has slightly higher rates. 

Basic Salary

This is the fixed part of your employee’s pay. It forms the base of their taxable income. There are no exemptions here, and the entire amount is taxed.

Allowances

Your employee’s salary has different allowances, and most of them are taxable.

• • DA and CCA: Always fully taxable.
  • HRA: Employees can save tax if they pay rent and keep receipts. The exemption depends on their city, salary, and rent paid.
  • Other allowances: Like special allowance, travel allowance (if paid as a fixed sum), or overtime, these are taxed unless reimbursed.

Perquisites (Perks)

These are the “extras” you give to your employees apart from salary.

• • Examples include rent-free housing, company cars, paid club memberships, or complimentary meals.
  • The value of these perks gets added to their income and taxed. Some are tax-free, such as laptops given for work or subsidized canteen meals under ₹50 per meal.

Variable Pay

Bonuses, incentives, and commissions are all included in your employee’s salary. These are taxed in the year they are received and added to their total income.

Retirement Benefits

As an employer, you may contribute to PF, NPS, or superannuation funds for your employees. Up to ₹7.5 lakh a year (combined) is tax-free. Anything above that, plus the interest it earns, is taxed.

Gratuity

• • Government employees: Don’t pay tax on gratuity.
  • Private employees: Get an exemption, but only up to the lower of:

1. 1. 1. 1. The actual amount received
         2. ₹20 lakh (lifetime cap)
         3. 15 days’ salary × years of service (as per formula). Any extra is taxed as salary.

Leave Encashment

• • During service: Fully taxed.
  • At retirement:

1. 1. 1. Government employees: fully tax-free.
      2. Private employees: exempt up to ₹25 lakh or as per the formula in Section 10(10AA).

Severance Pay

The money your employees get for losing their jobs is normally taxed as salary. But compensation under the Industrial Disputes Act is tax-free up to ₹5 lakh. For big payouts, employees can claim relief under Section 89 by filing Form 10E.

Voluntary Retirement Scheme (VRS)

Money from a VRS is tax-free up to ₹5 lakh, but only if it meets certain conditions (like age and years of service). Anything extra is taxed.

The table below gives you a clearer picture of all the taxable components.  

Let’s move on to our next section and see what tax implications employers have in India.

What Are the Tax Implications in India for Employers?

If you run a business in India, knowing the payroll components is crucial. There are tax implications at every step that can cost you penalties.

Tax Deducted at Source (TDS) on Salary

• • Calculation: You figure out TDS based on each employee’s annual income, the tax slab they fall under, and which regime they’ve chosen; old or new.
  • Deposit and Filing: Pay the deducted TDS to the government by the 7th of next month. March is an exception; you get until April 30. File Form 24Q every quarter to stay compliant.

Form 16

Give employees Form 16 by June 15. It’s their proof of how much tax you deducted and paid.

Provident Fund (PF)

• • Contribution Rates: Both employer and employee put in 12% of basic salary plus DA. Mandatory for companies with 20 or more employees.
  • Limit: The employer’s total contribution across PF, NPS, and superannuation is tax-free up to ₹7.5 lakh a year.
  • Deadlines: Deposit PF money with EPFO by the 15th of the next month. Miss it, and interest starts piling up.

Employee State Insurance (ESI)

• • Contribution Rates: Employers pay 3.25%, and employees pay 0.75% of gross wages. Only applies to employees earning ₹21,000 or less.
  • Deadlines: Pay ESIC by the 15th of the next month. This keeps your team covered for health and disability benefits.

Learn more about the payroll calendar in India. 

Professional Tax

• • Maximum Limit: Some states charge it, some don’t. When they do, the max is ₹2,500 a year.
  • Employer Role: You deduct it from salaries and send it to the state government.

Taxability of Employee Benefits (Perquisites)

• • Examples: Free housing, a car for personal use, or gifts over ₹5,000, all of these are taxable.
  • Employer Responsibility: You’re the one who has to calculate the value, add it to the salary, and deduct the right TDS.

Calculate Indian employee’s salary on your own through our salary calculator.

Penalties for Non-Compliance

Here’s where the tax implications get serious:

• • Interest: 1% per month if you delay deduction, 1.5% if you delay payment.
  • Expense Disallowance: Tax authorities can block salary expenses as deductions if you miss TDS.
  • Fines: Late filings mean more money out of your pocket.
  • Legal Trouble: Worst case? Prosecution or losing your business license.

Let’s now see how tax implications in India work with the help of an employer of record.   

How Do Employer of Record Tax Implications Work in India?

Tax compliance in India can get tricky fast with all the payroll, EPF, GST, and the works. Using an Employer of Record (EOR) makes it much easier. 

Most tax implications are handled by the EOR, reducing risks for the company and employees, but there are still a few areas you need to watch closely.

EOR Tax Responsibilities

The EOR is the legal employer, so most tax implications fall on them. They take care of payroll, deductions, and statutory filings, making life easier for both the company and employees.

Income Tax (TDS): The EOR calculates TDS as per the latest income tax slabs. They deduct it monthly, deposit it with the government, and issue Form 16 for annual tax filing. This ensures zero last-minute tax surprises.

Provident Fund (EPF): EOR contributes the EPF percentage equal to the employer and deducts the employee’s share too. This not only keeps you compliant but also builds your employees’ retirement savings.

Employee State Insurance (ESI): An EOR takes care of the ESI deductions on the employer’s behalf.

Professional Tax (PT): The EOR calculates this state-level and highly variable deduction at the right amount and remits it monthly to avoid penalties.

Statutory Bonuses: EOR checks eligibility under the Payment of Bonus Act, calculates bonuses, and deducts applicable tax before crediting employees.

Leave Encashment & Gratuity: When employees encash leaves or receive gratuity after 5+ years of service, the EOR calculates and deducts the right tax, staying compliant with Indian labor laws.

Client Company Tax Implications

Using an EOR doesn’t mean zero tax responsibility for the client company. Here’s what to keep an eye on.

Permanent Establishment (PE) Risk: The biggest concern in Employer of Record tax implications is PE risk. If your team’s activities in India create a fixed place of business or act as an agency, your company could be liable for corporate taxes in India. A properly structured EOR setup helps keep this risk low.

GST on EOR Fees: The service fees you pay your EOR attract 18% GST. This is usually claimable as an input credit if you’re GST-registered in India.

Employee Tax Considerations

Employees hired through an EOR face the same tax implications as regular salaried employees. The EOR manages deductions, but employees must stay proactive, too.

Income Tax Filing: Employees still need to file their annual tax return. The EOR makes it simple by issuing Form 16 with all deductions already reported.

Choice of Tax Regime: Employees can choose between the old regime (more deductions and exemptions) and the new regime (lower rates but fewer deductions).

Tax-Saving Options: The EOR can help optimize take-home salary through HRA, standard deduction, and other allowances to minimize tax outgo.

Double Taxation Relief: For foreign employees, the EOR ensures compliance with DTAA provisions so income isn’t taxed twice, once in India and again abroad.

We’ll now see how an EOR handles any negative tax implications in India.  

Learn how to use an EOR to manage payroll services in India

How Can an Employer of Record Help Manage Tax Implications in India?

An employer of record handling tax implications is all about reducing risk and staying compliant. 

An EOR becomes the legal employer, so the tax risks sit on their books, not yours. Here’s how they protect you from trouble and help you stay compliant.

Late Filing Penalties

A missed Tax Deducted at Source (TDS) deadline can attract daily penalties and interest. 

EORs have automated payroll systems that track every filing date and submit returns on time. 

This protects you from paying fines or dealing with government notices.

Inaccurate Tax Withholding

Incorrect TDS, PF, or ESI calculations can result in audits, back taxes, and penalties. Since the EOR is the legal employer, they are accountable for any errors.

They ensure accurate calculations, issue corrected challans if needed, and handle compliance follow-ups. 

This way, you never face reputational or legal damage.

Statutory Contribution Defaults

Missing Provident Fund (PF) or Employee State Insurance (ESI) contributions can lead to recovery proceedings and even prosecution.

The EOR monitors contributions every payroll cycle, makes timely deposits, and handles interest or penalties if they ever occur. 

This takes the legal burden off your company.

Management of Tax Investigations

If an employee’s tax return is flagged for review, the EOR steps in as the point of contact. 

They provide necessary payroll records, coordinate with tax authorities, and keep your company name out of the process. 

This shields you from unnecessary exposure.

Tax Planning and Optimization

EORs don’t just handle compliance; they also help you save money through better tax planning for both your business and employees.

Tax-Efficient Salary Structuring

They design salary packages with tax-saving components like fuel allowances, internet reimbursements, meal cards, and professional development benefits. 

This helps employees take home more while staying compliant.

Handling Tax Regimes

Choosing between the old and new tax regimes can be tricky for employees. 

EORs guide them by comparing tax liabilities under both options, factoring in investments and deductions, so employees make the most tax-efficient choice.

Expatriate Tax Planning

For foreign hires, EORs manage double taxation risks. They help employees understand obligations in both home and host countries.

They also leverage DTAA (Double Taxation Avoidance Agreement) benefits and structure pay to minimize global tax impact.

Hence, an EOR makes your company an attractive workplace for employees, along with shielding you from any negative tax implications.

Conclusion 

Tax implications in India can take any shape at any point in time. You’ve to always be on your toes to check the constantly updating tax regulations here. 

And it’s better to have a shield for your business to operate without interruptions. It’s important to ensure that the employees are paid correctly and that all the filings and deductions are done properly.

The good news is you don’t have to manage everything on your own. An Employer of Record (EOR) can easily take this burden off your shoulders. 

They’re not only experts in handling tax implications, but also prove to be cost-effective in nature. 

That’s why they are your ideal employment partner in a foreign land like India.