Final Union Budget 2026-27: Key Payroll and Compliance Highlights for HR

The Finance Act 2026 has officially brought into effect the Income Tax Act 2025, replacing the 60-year-old 1961 Act. For HR and payroll teams, this marks the beginning of a new era of compliance. Effective April 1, 2026, payroll processes must align with the modernized code. Here’s what you need to know.

Summary: Key Payroll Compliance Updates (2026-27)

The changes span tax slabs, documentation, allowance limits, exit settlement timelines, and statutory deposit rules.

• Unified Tax Year – “Previous Year” and “Assessment Year” are now merged into a single Tax Year.
• Standard Deduction values (₹75,000 for New Regime, ₹50,000 unchanged for Old Regime).
• Zero‑tax threshold expansion (effectively ₹12.75 lakh under the New Regime after deduction + rebate).
• Documentation Changes:

-   **Form 130 replaces Form 16** – Must be system-generated via TRACES; manual issuance is invalid.

-   **Form 124 replaces Form 12BB** – For employee investment declarations.

-   **Form 123 replaces Form 12BA** – Mandatory perquisite statement, digitally linked to Form 130.

-   **Form 121 replaces Forms 15G/15H** – Unified self-declaration for nil TDS.

-   **Section Mapping** – TDS on salaries now falls under Section 392 (earlier Section 192).

• Revised Exemption Limits for Allowances and Perquisites
• HRA Metro City Expansion
• New Full & Final Settlement Rule
• PF & ESI Deposit Deduction: Relief on Employee Contribution Timing
• Quarterly TDS return change (Form 138 replacing Form 24Q).
• Revised return deadline (extended to March 31 of the subsequent tax year)

What are the official tax slabs and the Zero-Tax Threshold?

The New Tax Regime remains the default regime for Tax Year 2026-27, and the effective tax-free limit is ₹12.75 lakh gross salary for the tax year 2026-27. For an employee earning 12.75 Lakh gross salary, the 75,000 Standard Deduction (applicable only to the New Regime) brings their taxable income to exactly 12 Lakh. Under Section 87A, they receive a full rebate of 60,000, reducing their net tax to zero.

New Tax Regime: Default From April 1 | Income Slab (₹) | Tax Rate (%) | | --------------- | ------------------- | | 0–4 Lakhs | NIL | | 4–8 Lakhs | 5% | | 8–12 Lakhs | 10% | | 12–16 Lakhs | 15% | | 16–20 Lakhs | 20% | | 20–24 Lakhs | 25% | | Above 24 Lakhs | 30% |

Old Tax Regime: Still Available (Must Opt-In) | Income Slab (₹) | Tax Rate (%) | | --------------- | ------------ | | 0–2.5 Lakhs | NIL | | 2.5–5 Lakhs | 5% | | 5–10 Lakhs | 20% | | Above 10 Lakhs | 30% |

The Standard Deduction differs by regime. Under the New Regime, it is ₹75,000; under the Old Regime, it is ₹50,000. Employees must declare their regime choice to their employer at the start of the tax year (typically via Form 122 under the new Act), and this drives TDS computation for the entire year. Payroll systems must prompt this declaration before the April 2026 payroll run.

Form 130 Replaces Form 16: What HR Must Tell Every Employee

Under the Income Tax Rules 2026, Form 16 is replaced by Form 130 as the annual TDS certificate for salary income. The purpose is identical: it certifies tax deducted from salary and deposited with the government, but the process and format have changed significantly.

Employees will ask: "Where is my Form 16?" The answer: it is now called Form 130. However, the first Form 130 will be issued by June 15, 2027, covering Tax Year 2026-27. For the current filing cycle (FY 2025-26 / AY 2026-27), employers will still issue Form 16 under the old Act by June 15, 2026.

HRA Metro City Expansion: Payroll Configuration Update Required

Under Rule 279 of the Income Tax Rules 2026, Bengaluru, Hyderabad, Pune, and Ahmedabad are now classified as metro cities for HRA exemption purposes. This brings the full 50% HRA exemption (of basic salary + eligible DA) to eight cities. The complete list: Delhi, Mumbai, Kolkata, Chennai, Bengaluru, Hyderabad, Pune, and Ahmedabad. All other locations remain at 40%.

Critical Caveats — Read Before Updating Payroll

1. The HRA exemption is available under the Old Tax Regime only. Employees on the default New Regime cannot claim HRA exemption regardless of which city they live in.

2. The exemption amount is the lowest of three: (a) actual HRA received, (b) rent paid minus 10% of salary (basic + eligible DA), and (c) 50% of salary for metro employees or 40% for others. City classification changes item (c) only.

3. Employees paying annual rent above ₹1 lakh must submit the landlord's PAN to the employer.

For payroll teams: update city classification configurations in your payroll system for all employees in these four cities who are on the Old Tax Regime before processing the April 2026 salary.

Revised Exemption Limits for Allowances and Perquisites

To correct for years of inflation, the government has significantly revised the tax-free limits for specific allowances. The following are effective for Tax Year 2026-27:

Old Regime Only: Critical Payroll Note

It is important to explicitly state that these increased limits are only available under the old tax regime. Since the new regime is the default and excludes most exemptions under Section 10, an employee on the new regime will see ₹0 tax benefit from these higher limits.

Share Buybacks: Gains from share buybacks are now taxed as Capital Gains in the hands of the employee, rather than as dividend income taxed at the company level. This is relevant for ESOPs and equity compensation plans.

The 2-Working-Day Full & Final Settlement Rule

One of the most critical updates for 2026 comes from the New Labour Codes. The days of 30 to 45-day settlement cycles are over.

• Employers must settle all wages, including leave encashment and final salary, within two working days (48 hours) of an employee's last working day. This 48-hour settlement rule applies specifically to "Wages" as defined under the Code on Wages, 2019.
• This applies to all forms of exit, including resignation, termination, retrenchment, or retirement. Given this tight window, manual exit clearances are no longer feasible; automation is now a compliance necessity.
• Gratuity payments can continue to follow the 30-day statutory window under the Payment of Gratuity Act, 1972, unless otherwise notified.
• EPF transfers: follow separate EPFO processes and are not subject to the 48-hour rule.

Operational Reality for HR Teams

The 48-hour window means exit clearance processes (IT asset returns, reimbursement settlements, loan balance verification) must run in parallel, not sequentially. Manual exit workflows built around a 30–45 day cycle are no longer compliant. Automation of the F&F process is now a compliance necessity, not a convenience.

PF & ESI Deposit Deduction: Relief on Employee Contribution Timing

The Act brings significant relief for corporate compliance and vendor management:

PF and ESI Deposit Relaxation

Under Section 29 of the Income Tax Act 2025, an employer can now claim tax deductions for employee contributions (PF & ESI) as long as they are deposited on or before the employer's (corporate) Income Tax Return (ITR) filing due date.

This officially ends the harsh "double-penalty" era. Previously, a one-day delay beyond the 15th of the month meant paying labor law interest and losing the corporate tax benefit forever (permanent disallowance). Now, while interest for late payments still applies under the PF/ESI Acts, the tax deduction is protected as long as you deposit before the ITR deadline.

Revised Return Window

Budget 2026 also extends the deadline for employees to file revised income tax returns to March 31 of the subsequent tax year (from the earlier December 31 deadline). For Tax Year 2026-27, a revised return can be filed until March 31, 2028. This gives HR teams more breathing room for year-end corrections to TDS data.

Simplified Manpower TDS

TDS on payments for manpower supply services is now simplified, with prescribed rates applicable by service category (capped at 1% or 2%). Employers using staffing vendors should verify the applicable rate for their contracts.

Quick Reference: All Key Changes at a Glance

HR Compliance Action Checklist - April 2026

This checklist covers the minimum actions required before and through the April 2026 payroll cycle. Use it as an internal audit tool.

Stay Compliant Without the Manual Work with greytHR

Annual compliance changes of this scale (new tax slabs, new forms, new metro cities, new statutory timelines) can overwhelm even experienced HR and payroll teams when managed manually. greytHR is already updated for Tax Year 2026-27, with automated support for the new tax regime configurations, HRA metro classifications, F&F settlement workflows, and TDS return generation under the new forms framework.

Automate your payroll and stay compliant. Book a demo to see how greytHR works.

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FAQs

What is the effective zero-tax limit for salaried employees in 2026-27?

It is ₹12.75 lakh gross salary under the New Tax Regime, after the ₹75,000 Standard Deduction reduces taxable income to ₹12 lakh, and the Section 87A rebate of ₹60,000 eliminates the remaining tax liability.

Is the Old Tax Regime still an option?

Yes, but it is not the default. Employees must explicitly opt for it if they want to claim deductions like HRA or 80C.

When does the Income Tax Act 2025 start?

It officially replaces the 1961 Act starting April 1, 2026.

What is the Standard Deduction under each regime?

For Tax Year 2026-27, the Standard Deduction is ₹75,000 under the New Regime and ₹50,000 under the Old Regime.

What is the new Section number for Salary TDS?

Salary TDS is now governed by Section 392 under the Income Tax Act 2025 (earlier Section 192).

Can I still claim HRA and 80C deductions?

Only under the Old Regime. The New Regime (default) does not allow these deductions, although the Standard Deduction (₹75,000) still applies.

What is the 48-hour settlement rule, and how does it work?

Under the New Labour Codes, employers must settle all wage-related dues, including salary, leave encashment, and retirement benefits, within two working days (48 hours) of an employee’s last day of service. This applies to all forms of exit, including resignation, termination, retrenchment, or retirement.

Does the 48-hour F&F settlement rule apply to gratuity?

No. The 2-working-day / 48-hour rule (Section 17(2), Code on Wages, 2019) applies to 'wages' — unpaid salary, leave encashment, and similar dues. Gratuity is governed separately by the Payment of Gratuity Act, 1972, which provides a 30-day window from when it becomes due.

What happened to Form 16?

It is replaced by Form 130 under the 2025 Act. It must be generated via TRACES and cannot be issued manually.

Which new cities qualify for 50% HRA?

Bengaluru, Hyderabad, Pune, and Ahmedabad have been added to the metro list for HRA purposes.

What is Form 124?

Form 124 replaces Form 12BB. It is the mandatory form for employee investment declarations (covering HRA, home loan interest, LTA, and other claims) submitted to the employer.

Are interest-free loans from employers still taxable?

Only if the aggregate loan amount exceeds 2,00,000. Loans below this limit (or for specified medical treatments) are now tax-free perquisites.

Summing Up

The Union Budget 2026-27 establishes a simplified framework for payroll compliance, ranging from updated tax slabs to accelerated settlement timelines. HR leaders can effectively navigate these changes by embracing automation to ensure total accuracy and regulatory alignment. Adopting digital tools allows teams to maintain seamless compliance while dedicating their primary focus to organizational growth and culture building

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Disclaimer: This blog is intended for informational purposes only and reflects the provisions of the Income Tax Act 2025, Income Tax Rules 2026, Finance Bill 2026, and the Code on Wages 2019, as understood at the time of publication. Tax and labour law compliance is subject to notifications and state-level rules. Readers are advised to consult their legal and tax advisors for specific guidance.