Provisions of Gratuity Fund and accounting thereof as contained in:
- Payment of Gratuity Act, 1972
- Income Tax Act, 1961
- Accounting Standard 15 – Employee Benefits
- Indian Accounting Standard 19 – Employee Benefits
Brief introduction:
Gratuity is a lumpsum amount paid by an employer to its employees at the time of their retirement, superannuation or death. It is a way by which an employer expresses its thankfulness to its employees for remaining in continuous service.
Gratuity, a word derived from gratitude, is a reward given voluntarily. However, in India, due to the enactment of Payment of Gratuity Act, 1972 (the Gratuity Act), it has become a statutory liability to be paid by all organisations covered under the Gratuity Act.
The Gratuity Act, inter alia, specifies:
(i) “Employees” eligible for receiving Gratuity [Sec 2(e)].
(ii) the method for computing the gratuity amount [Sec. 4(2)].
(iii) the time when gratuity becomes payable [Sec. 4(1)].
(iv) the maximum amount which can be paid under the Act [Sec 4(3)].
The Gratuity Act further states the manner in which the gratuity liability of an organisation should be provided for. Under section 4A of the Gratuity Act, the following methods have been prescribed:
(i) Obtain a Gratuity Insurance from Life Insurance Corporation of India [Sec. 4A(1)]
(ii) Establish an Approved Gratuity Fund and contribute periodically [Sec. 4A(2)]
Scenario:
A public limited company incorporated under Companies Act 2013. It is desirous of setting aside funds on a periodic basis to meet gratuity liabilities under Payment of Gratuity Act, 1972. It has following 3 options:
Option 1: Purchase a Gratuity Insurance from LIC or any approved Insurer
Option 2: Establish a gratuity fund, get it approved under provisions of Income Tax Act and contribute to it on a periodic basis. This fund invests the contribution in accordance with the conditions laid down in the Income Tax Act, 1961.
Option 3: Neither opt for Gratuity Insurance nor establish Approved Fund. Simply create a Provision for Gratuity in its books of accounts.
Kindly note: It is advised that Actuarial Valuation Report be obtained from an Independent Actuary under all options [para 49 of AS 15]. The Report will calculate the closing value of defined benefit obligation and fair value of planned assets. It also states the amount to be recognised in financial statements as per Accounting Standard 15 or Indian Accounting Standard 19.
For the purpose of this article, only the option of establishing and contributing to Approved Gratuity Fund has been analysed.
Analysis of Option 2: Establish a Gratuity Trust and get approval.
Section 2(5) of the Income Tax Act, 1961 defines an approved gratuity fund as a gratuity fund which has been and continues to be approved by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner in accordance with the rules contained in Part C of the Fourth Schedule.
Under this option, ABC Ltd. (the Employer) is required to:
1. Establish “ABC Ltd. Employee Gratuity Fund Trust (the Trust)”exclusively for meeting the Gratuity liability of its employees by executing a duly registered Trust Deed. The Trust should be an irrevocable trust.
2. Appoint atleast two Trustees. A Company can be appointed as a Trustee only on approval of Chief Commissioner or Commissioner.
3. Make all employees member/beneficiary of the Trust. Not less than 90% of the employees should be employed in India. A director may be admitted as a member/beneficiary of the Trust only if he is a Whole Time Director or Managing Director and does not hold shares in the Company carrying more than 5% of the total voting power.
4. Make an application to the Income Tax Authority appointed for granting approval. The form for application is specified in Rule 109 of Part C of Fourth Schedule to Income Tax Act, 1961. This application has to be made in the name of the Trust.
5. Start contributing to the Trust once approval has been granted in writing.
6. In case the approval has been refused, an appeal may be made to CBDT in Form 44.
An approved gratuity fund has been accorded a separate legal entity under the Income Tax Act. This would imply that:
1. The trust must have its own PAN card.
2. The trust must have a separate bank account preferably with a scheduled bank (See rule 101 of Income Tax Rules, 1962).
3. The trust must maintain its own books of accounts (see rule 109(1)(c) of Income Tax Rules, 1962).
Since an approved gratuity fund is a private discretionary trust, it would be assessable as an AOP for Income Tax purpose – Clause (iv) of first proviso to section 164(1).
For any assistance required with respect to Gratuity trust, superannuation trusts or any employee benefit schemes, do connect on below mentioned email id a1consultancyservices @ yahoo.com or call on 8080324970
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