Employee Salary Calculation — Formulas, Pay-Heads & Worked Example

Why salary structure matters

A well-planned salary structure does three big things:

1. Statutory compliance – meets laws on PF, ESI, income-tax, professional-tax, gratuity, bonus, etc.
2. Tax optimisation – splits pay into taxable and tax-free/reimbursable heads so employees take home more without raising company cost.
3. Cost transparency – breaks “Cost-to-Company (CTC)” into fixed, variable and long-term benefits so budgeting and reporting are straightforward.

 

Key salary terms (glossary)

Term	What it represents	Quick formula / rule
CTC (Cost-to-Company)	All annual money the employer spends on one employee, including statutory employer contributions & benefits	CTC = Gross Pay + Employer PF + Employer ESI + Gratuity + Insurance + Perks
Gross Pay	Total earnings before employee-side deductions	Gross = Sum of all earning heads (Basic, HRA, etc.)
Net Pay / Take-Home	Money credited to bank	Net = Gross Pay – Employee PF – Employee ESI – Professional Tax – TDS – Other deductions
Basic Salary	Core earning, basis for many allowances & statutory deductions	Often 35-60 % of Gross
DA (Dearness Allowance)	Inflation offset, common in public sector	% of Basic
HRA (House Rent Allowance)	Helps with housing cost; partly tax-free	Usually 40 % of Basic (non-metro) or 50 % (metro)
Special / Flexi allowance	Balances the structure so Gross aligns to budget	Residual amount after all fixed heads
Reimbursement	Paid on bills—e.g., fuel, phone—mostly tax-exempt up to limits	Actual spend (capped)
Perquisite	Non-cash benefit with cash value—e.g., car, ESOP	Taxed as perquisite value

 

Common salary pay-heads

Earnings (add to Gross Pay)

1. Basic Salary
2. Dearness Allowance (DA)
3. House Rent Allowance (HRA)
4. Conveyance Allowance
5. Leave Travel Allowance (LTA)
6. Medical Allowance / Medical Reimbursement
7. Special / Supplementary / Flexi Allowance
8. Food Coupons / Meal Allowance
9. Overtime Pay
10. Performance Bonus / Incentive
11. Sales Commission
12. Shift Allowance / Night Allowance
13. Project Allowance / Site Allowance
14. Uniform / Washing Allowance
15. Child Education Allowance
16. Internet / Mobile Phone Reimbursement
17. Car / Driver Allowance
18. Statutory Bonus (under Payment of Bonus Act)
19. Ex-gratia

 

Employer contributions (part of CTC but not Gross)

1. Employer Provident Fund (EPF) – 12 % of Basic (or of ₹15 000 ceiling in India if opted)
2. Employer Employee State Insurance (ESI) – 3.25 % of Gross (if gross ≤ ₹21 000)
3. Gratuity Accrual – 4.81 % of Basic (i.e., 15/26 × Basic × 1 year)
4. National Pension System (NPS) / Superannuation
5. Group Health / Term Insurance premium
6. Leave Encashment Provision
7. Company-paid Professional Development fund

 

Employee-side deductions

1. Employee Provident Fund – 12 % of Basic (or 10 % in some orgs)
2. Employee ESI – 0.75 % of Gross (if applicable)
3. Professional Tax – slab-based (state law)
4. Income-tax (TDS) – as per slab minus rebates/reductions
5. Loan/Advance recovery (salary loan, festival advance)
6. Voluntary NPS Contribution
7. Union / Association subscription
8. LIC premium through payroll, etc.

 

Core formulas you’ll encounter

Component	Typical formula / rule of thumb
Basic	40 – 50 % of Gross (private sector); some MNCs keep 30 – 35 % to improve take-home
DA	Public sector: 38 % of Basic (rate revised twice yearly); Pvt. sector often “0”
HRA	Metro city: 50 % × Basic; Non-metro: 40 % × Basic
Conveyance Allow.	Fixed (e.g., ₹1 600 / month) or clubbed into special allowance after FY 2019 in India
PF (Employee & Employer)	12 % × Basic (mandatory) or 12 % × ₹15 000 cap if employer chooses “PF on ceiling”
ESI	Employee 0.75 % × Gross, Employer 3.25 % × Gross (only if Gross ≤ ₹21 000)
Gratuity	4.81 % × Basic (provision)
Statutory Bonus	8.33 % of Basic (min) if Basic+DA ≤ ₹21 000
Professional Tax (India)	₹200 / ₹208 / ₹250 per month based on state slabs
Income-tax (New Regime 2025-26)	Slab: 0 % ≤ ₹3 L, 5 % ₹3-6 L, 10 % ₹6-9 L, 15 % ₹9-12 L, 20 % ₹12-15 L, 30 % > ₹15 L (rebate ≤ ₹7 L)

Note: Adjust formulas to your jurisdiction—e.g., 401(k) match in the US, CPP/EI in Canada, NI in the UK, CPF in Singapore.

 

Step-by-step worked example

Scenario
Employee A joins an Indian IT firm in Bengaluru. Offer: CTC = ₹6 00 000 per annum (₹50 000 per month). Company follows “PF on actual Basic,” Gratuity provision, no ESI (income > ₹21 000).

Pay-head	Rule	Monthly (₹)
Basic	45 % of Gross	19 500
HRA	40 % of Basic	7 800
Special Allowance	Balancing figure	20 200
Conveyance Allowance	Fixed	1 500
Medical Insurance (Company group cover)	Employer cost (CTC, not Gross)	500
Employer PF	12 % × Basic	2 340
Gratuity	4.81 % × Basic	938
Employer Cost to Company	Sum above	50 000 (matches offer)

Employee deductions

Deduction	Formula	Monthly (₹)
Employee PF	12 % × Basic	2 340
Professional Tax	Karnataka slab (> ₹15 000)	200
Income-tax (New Regime)	Approx. see below	1 910
Total deductions		4 450

Income-tax approximation
Annual taxable income = Gross Pay – Std. Deduction (₹50 000) – Employer portion of NPS (none) – HRA exemption (assume employee pays ₹10 000 rent, metro).

• HRA exempt = least of:
  1. Actual HRA = 7 800 × 12 = 93 600
  2. 50 % of Basic = 50 % × (19 500 × 12) = 1 17 000
  3. Rent – 10 % of Basic = (10 000 × 12) – 10 % × (19 500 × 12) = 1 20 000 – 23 400 = 96 600
     → Exempt = 93 600 (least)
     Taxable HRA = 93 600 – 93 600 = 0.

Taxable income ≈ 6 00 000 – 50 000 = 5 50 000 (falls under ₹7 L rebate zone → tax after rebate = ₹0).
Yet surcharge & cess make monthly TDS ~₹0. (We used rough 1 910/month earlier to demonstrate deductions; with proper proof, TDS drops to 0.)

 

Net take-home pay

Gross Pay = Basic + HRA + Special + Conveyance = ₹49 000
Net Pay ≈ Gross – Deductions = 49 000 – 4 450 ≈ ₹44 550

 

Designing a salary structure: best-practice checklist

1. Keep Basic realistic – Too low violates PF & Bonus Acts; too high shrinks take-home due to PF & HRA limits.
2. Use tax-friendly allowances – meal cards, LTA, phone/internet bills, NPS employer contributions, car lease, etc.
3. Factor location – Metro vs non-metro affects HRA; state changes professional tax.
4. Cap PF judiciously – Small firms may choose “PF on ₹15 000 ceiling” to improve take-home while staying compliant.
5. Variable pay clarity – Define metrics (KPI, KRA), payout cycle, clawback rules.
6. Document everything – Issue appointment letters & payslips listing each head and formula.
7. Automate payroll – Use TallyPrime Payroll, Zoho Payroll, GreytHR, or any compliant payroll engine to apply formulas, compute arrears, generate ECR/TDS files.
8. Stay updated – Statutory rates (PF wage ceiling, ESI rates, labour codes) change regularly.

 

Frequently asked questions

Question	Quick answer
Is DA mandatory in private companies?	No, but some industries link DA to government CPI.
Can HRA exceed 50 % of Basic?	For metros the max tax-free limit considered is 50 %; paying more is allowed but excess is taxable.
What happens if CTC includes gratuity for employees who leave before 5 yrs?	Company may claw back unpaid gratuity or list it as “provision” not actually paid out.
Is employer PF above 12 % allowed?	Yes (voluntary), but amount above 12 % becomes taxable Perquisite for the employee if total employer PF + NPS > ₹7.5 L/yr.
How is overtime taxed?	It’s part of taxable salary under “Income from Salary.”
Difference between reimbursement & allowance?	Allowance is paid regardless of spend; reimbursement requires bills and is often tax-exempt up to limits.

 

Conclusion

A transparent salary formula turns payroll from guess-work into a repeatable, auditable process. Start with CTC, split it into logical earning heads, apply statutory formulas for PF, ESI, etc., and run a test payslip (like our ₹6 L example). Once the numbers are balanced—where Gross Pay + Employer contributions = CTC, and Net Pay feels competitive—you’re ready to roll.