Are you confused between payroll tax and income tax? Let us clear it out simply. If you are an HR professional working in India, there must have been enough times when you have changed the pay slip & tax compliance. Nevertheless, even experienced HR departments sometimes get confused by payroll tax with income tax, which is quite logical. The two are often used in the same context, while in fact, they refer to two different responsibilities that have different effects on both employees and employers.
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Read more to understand the difference of payroll tax vs income tax!
What Are Payroll Tax and Income Tax?
Generally, payroll tax is compulsory payments made by an employer and is made up of deductions and contributions to statutory bodies. These include Employee state insurance, Employee provident fund, state professional tax, and others. These are not part of an employee’s income tax, yet are standard employer-side statutory duties.
Income tax, as the name suggests, is a direct tax that is the responsibility of the employees based on their total income which includes but is not limited to the salary received, rents, capital gains, etc. The employer deducts the tax at source (TDS) and pays it to the Income Tax Department.
Payroll Tax vs Income Tax: At a Glance
Here’s a quick difference between payroll tax and income tax to clear things up:
| Feature | Payroll Tax | Income Tax |
|---|
| Who Pays? | Employer on behalf of employees, Partially by employees as well. | Employee (deducted from salary) |
| What It Covers | PF, ESI, Professional Tax | Tax on total income including salary, rent, investments |
| Calculation Basis | Fixed % of salary/wages | Progressive slab based on annual income |
| Deducted From | Partially from employee’s salary (PF, ESI); employer also contributes | Fully deducted from employee’s taxable income |
| Refund Possibility | Not applicable – these are statutory contributions | Refund possible if excess tax deducted (via ITR filing) |
| Filed By | Employer files returns with EPFO, ESIC, state PT departments | Employee files ITR; employer files TDS returns |
| Applicable Laws | EPF Act, ESI Act, State PT Acts | Income Tax Act, 1961 |
| Compliance Frequency | Monthly remittance and filings | Annual ITR; quarterly TDS filing by employer |
| End Use | Funds employee social benefits (pension, insurance, healthcare) | Used for national development and public services |
| Thresholds | PF: salary < ₹15,000/month ESI: salary ≤ ₹21,000/month | Taxable income > ₹2.5 lakh annually (for individuals under 60) |
Payroll Deductions vs Income Tax: How Are They Calculated?
It is not just enough for HR professionals and finance teams to know definitions, it is important to know the calculations as well. Between payroll deductions and income tax, there are variations in rates and conditions. To make it easy to understand, let us differentiate it below with what is being deducted, who incurs the expenses, and where the money is used.
1. Payroll Tax Deductions (Employer & Employee Contributions)
Payroll deductions involve statutory allocations made by the employer and the employee where most of the allocations are towards employee welfare.
| Provident Fund (PF) | Employee contribution: 12% of basic salary Employer contribution: 12% of basic salary (split between EPF, EPS, and EDLI) |
| Employees’ State Insurance (ESI) | Eligibility: Applicable if gross salary is ₹21,000/month or less Employee share: 0.75% Employer share: 3.25% |
| Professional Tax (PT) | PT is Levied by state governments. For instance, in Maharashtra, If the salary is above ₹10,000/month, then the PT would be ₹200/month. |
Note: A study made by KPMG, India revealed that more than 93% of the salaried employees in the organized sectors are covered with the PF and ESI. Therefore, these deductions form part of regular payroll operations.
2. Income Tax (TDS – Employee Obligation)
Income tax is not a payroll tax as such, but it is paid through deductions at source every month under the TDS provisions. It is calculated based on the monthly earnings of the employee, the tax system whether old or new, and any allowable deductions.
Here’s a snapshot of the old tax regime for FY 2024–25:
- Up to ₹2.5 lakh: Nil
- ₹2.5 lakh – ₹5 lakh: 5%
- ₹5 lakh – ₹10 lakh: 20%
- Above ₹10 lakh: 30%
Note: As reported by the McKinsey India Taxation Review 2024, income tax forms 43% of the total direct tax in India, making it a vital component of the country’s direct-tax revenues.
3. The Cumulative Impact
Cumulative pay refers to the total cost incurred by an employee with respect to payroll deductions and income tax. Payroll taxes such as the PF and PT therefore remain constant while the Income Tax depends on the total earnings of the employee and the relevant tax laws.
Let’s take an employee in a metro earning ₹50,000/month:
- PF Deduction: ₹6,000/month (12%)
- Professional Tax: ₹200/month (in Maharashtra)
- Income Tax: ~₹3,900/month (assuming ₹46,800 annually, without exemptions)
This is more than ₹1.3 lakh annually towards statutory and tax expenses.
Did you know? A 2023 PwC India Payroll Survey showed that 41% of mid-sized Indian companies have a bad record of identifying which part of the payroll is taxable, resulting in a mismatch of TDS and unsatisfied employees.
Conclusion: Why HR Needs to Know the Distinction
It is important to differentiate the payroll tax from the income tax not only in the sense of the legal framework but also in terms of achieving the rationalization of the payroll. With India’s workforce becoming more digitally connected and financially savvy, HR leaders should be prepared to solve employees’ queries on taxation, filing, and positioning payroll correctly, in response to changing rules of labor laws and new digital tax regimes.
HR teams are not just calculating salaries for their employees but also inspire trust through tax-efficient planning and compliance. Learning this today prepares you for the taxes of tomorrow.