Taxation of gratuity fund

CA Mehul Chudasama (Chartered Accountant) (618 Points)
Replied 28 January 2016

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CA Mehul Chudasama (Chartered Accountant) (618 Points)
Replied 28 January 2016

Under Section 10 (10)

Gratuity is retirement benefit paid by the employer for years of loyal and dedicated service. Gratuity received by Government employee is fully exempt from tax. Taxability of Gratuity of a Private Sector employee covered by Gratuity Act is explained in this article.

Gratuity is a gift or gratuitous payment by the employer for prolonged service offered by his employee. After introduction of the Gratuity Act in 1972, Gratuity has become legally compulsory in most of the cases. Certain amount received as Gratuity is exempt from tax. From the 3 conditions mentioned below, the amount which is the lowest is exempt from tax.

Tax exemption is calculated by multiplying 15 days of salary based on the last salary drawn with no. of years individual is in service.
For example: If an employee works for 8 years and his 15 days of salary equates to Rs 15000, tax exemption amount will be calculated as 15000 x 8.
For employees of seasonal nature, tax exemption is calculated by multiplying 7 days of salary based on last salary drawn with no. of years individual is in service.
Individual can claim maximum exemption of 10,00,000 in his lifetime. E.g. If the Gratuity exemption claimed in FY 2009-10 Rs. 2 lakhs, upto Rs. 8 lakhs can be claimed in the future.
Actual Gratuity received at the time of retirement.

After exemption, the balance amount is taxable. Other key considerations while calculating tax exemption on Gratuity are as follows:

Salary, when calculated for tax exemption purpose, includes Dearness Allowance. But Bonus, Commission, House Rent Allowance, Overtime, Wage and any other allowances are not included or calculated as Salary.
For calculating salary of a day, a month is considered to be of 26 days.

If period of service is less than 6 months it shall be ignored. It shall be taken into consideration as a year only if the service period is more than 6 months.

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Pushkar Apte (Direct Tax Expert) (36 Points)
Replied 28 January 2016

Dear,

I know very well about taxation of gratuity in the hands of an individual.

I had asked about income of Gratuity fund which is registered as AOP. The income of grauity fund is exempt U/s. 10(25)(iv) of the Act. However I wanted to confirm whether this exemption applies to Gratuity fund AOP or Gratuity Fund trust.

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CA Mehul Chudasama (Chartered Accountant) (618 Points)
Replied 28 January 2016

Gratuity fund is generally established in the form of a trust. A few employees become the trustees of such fund. The contributions made towards the Gratuity fund generally depends on the Actuarial Valuation. However, an employer may approach a life insurer in order to purchase a group gratuity plan. The Gratuity trust can invest its funds by making a contribution under a Group Gratuity Scheme of an insurer. Thus, the employer has to pay annual contributions to the insurance company as decided by the insurance company. The gratuity will be paid by the insurance company based upon the terms of the group gratuity scheme. Approved Gratuity Funds Section 2(5) of the Act defines an ‘approved gratuity fund’ as ‘a gratuity fund which has been and continues to be approved by the Chief Commissioner or Commissioner in accordance with the rules contained in Part C of the Fourth Schedule’. In order to get the approval of the chief commissioner or commissioner, an application needs to be made under Rule 109, including prescribed particulars regarding the employer, nature of business of the employer, employees eligible to participate in the fund and verified in the prescribed manner. Final Conclusion: if your gratuity fund registered u/s under rule 2 (1) part 'c' of part 'C' Schedule of It act than ---- Income of an approved gratuity fund is exempt under Section 10(25)(iv).

Tikaram Chaudhary (Founder of Gratuity Trust Fund Consultant) (2187 Points)
Replied 26 December 2017

In this article I would like to draw your kind attention towards the benefits of creating Group Gratuity Trust Fund & Impact on Financial Statements of Companies due to change in the Ceiling limit of Gratuity Amount Payable to employees from "Ten Lakh Rupees" to "Twenty Lakh Rupees" as The Payment of Gratuity (Amendment) Bill, 2017 introduced in the Lok Sabha on 18 December 2017 for this purpose. You can access the bill by clicking on the following link:

https://goo.gl/QYJUwt

As stated above in the notice of the Bill, it proposes to substitute the words "ten lakh rupees" with the words "such amount as may be notified by the Central Government from time to time" in Sub-Section (3) to Section 4 of The Payment of Gratuity Act, 1972. Thus, the proposed Bill seeks to empower the Central Government to notify the ceiling proposed, instead of amending the said Act, so that the limit can be revised from time to time keeping in view the increase in wage and inflation, and future Pay Commissions.

If the above Bill is passed by both Houses of Parliament in the current winter session, we expect the government to notify increase in gratuity limit (to Rs. 20 Lacs) before 31 March 2018.

Impact on Gratuity Liability due to change in Gratuity Ceiling Limit

As we expect the government to notify increase in gratuity limit (to Rs. 20 Lacs) before 31 March 2018 then it will have a bearing impact on the Financial Statements of 31.03.2018 such Balance Sheet and Profit/Loss of Private Sector Companies because the Gratuity Liability of Private Sector Companies will increase many folds where employees has already accrued their gratuity benefits above 10 lakh but their accrued benefits are restricted due to ceiling of 10 lakh.

The following table available following web-link shows this impact :-

https://goo.gl/gskb25

The above table is based on the accrued gratuity benefits by considering their accrued service till 31.03.2018 & basic salary of 31.03.2018 as qualifying salary for their Gratuity benefit computation. From results in above table, we may conclude :-

1. That the accrued liability of 20 employees for their accrued service as on 31.03.2018 for their basic salary of Rupees 13,86,536/- calculates to Rupees 2,15,45,166/- as shown in Col.4 but due to monitory ceiling limit of 10 Lacs as per The Payment of Gratuity (Amendment) Act, 2010 , company liability is restricted to Rupees 1,28,73,977/- as Shown in Col. 5 of the above Table.

2. That the company liability has changed dramatically to Rupees 1,81,50,784/- from Rupees 1,28,73,977/- due to changes Ceiling limit of Gratuity Amount Payable to employees from "Ten Lakh Rupees" to "Twenty Lakh Rupees" by Rupees 52,76,807/- which is 40.99% of the original liability of Rupees 1,28,73,977/ at ceiling limit of 10 Lakh.

3. If the ceiling limit is abolished then the liability will be Rupees 2,15,45,166/- which is almost 167% of the original liability of Rupees 1,28,73,977/- at ceiling limit of 10 Lakh.

From above example, we may conclude that Amendments in the Act can not be regulated by the Companies similarly their impacts of such changes on their Financial Statements but Companies can smartly reduce bearing impacts of such changes in the Act by Creating a Group Gratuity Trust Fund.

Types of Group Gratuity Trust Funds

The funds of the trust can either be invested by the trustees or alternatively the funds may be let out to LIC who will then invest & give a specified return on the trust fund. The administrative work of the trust however is the responsibility of the trustees.

The identity of the trust fund is separate from that of a company and the company has no right over the money available in the fund. As the amount of gratuity payable is a function of the terminal salary and the number of years of service put in, the gratuity liability goes on increasing year after year. It is advisable to set aside each year's liability out of the profits and gains of that year.

Approval of the Income Tax Commissioner is necessary at the time of formation of the trust and whenever rules are amended.

In case of Self Managed Trust, investment of funds will have to be done as per Income-Tax Act, by the trustees and entire administration of the Trust including Actuarial Valuation will be the responsibility of the Trustees. All monies standing to the credit of the bank account to the extent not required for settlements /transfers / withdrawals etc pertaining to the members shall be invested by the Trustees in the manner prescribed by the Government of India vide Rules 101 & 67 of Income Tax Rules, 1962 from time to time.

In case of LIC managed funds of the trust, companies will get following benefits :-

(i) The job of investment and interest is paid by the Corporation on the accumulated funds.

(ii) In case of death while in service, the service period is counted while calculating the gratuity as if the person has served the company up to his Normal Retirement Date.

(iii) LIC maintains the fund under the name of trust.

(iv) Investment of funds is taken care by LIC & Interest is declared as per the performance of Total Fund and credited to the individual trust fund.

(v) At the time of exit of employee, trustee send discharge and advice LIC to make payment of Gratuity as per Scheme to the Trust.

(vi) Tax benefits are as per the provisions of the Income Tax Act, 1961. Such as contribution to LIC are treated as business expenses to the company and Interest earning are Tax Free. (Tax laws are subject to change.)

The above tax benefit as stated in (vi) above is not available to the companies who make the provision of Gratuity in their Balance Sheet as per the provisions of Accounting Standard-15 (Revised 2005) and IndAS 19.

If you or your client have any requirement of of Creating Group Gratuity Fund or you looking for a experienced consultant for the above purpose then you may contact me.

The above article is also available at my blog : https://groupgratuityfundconsultantindelhi.blogspot.in

(Disclaimer :-This is a personal article. Any views or opinions represented in this article are personal and belong solely to the article owner and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated. Any views or opinions are not intended to malign any religion, ethnic group, club, organization, company, or individual.)

Chandrakant (Chartered Accountants) (33 Points)
Replied 11 January 2019

But generally the Income Tax Department delay recognition for many year and give approval from current date. In period between application and approval is considered as unrecognised trust and exemption under Section 10(25)(iv) is denied by the Department What is remedy for it.

Tikaram Chaudhary (Founder of Gratuity Trust Fund Consultant) (2187 Points)
Replied 02 March 2019

Tax Benefits of setting up a Gratuity Trust?

Gratuity benefits are governed by “The Payment of Gratuity Act 1972” and paid by the Company to an employee in addition to his salary on exit from the company. Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years, –

(a) on his superannuation, or
(b) on his retirement or resignation, or
(c) on his death or disablement due to accident or disease:

Provided that the completion of continuous service of five years shall not be necessary where the termination of the employment of any employee is due to death or disablement:

Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal benefit. It means, Gratuity amount can be determined only on the monthly terminal wages of the employee on his exit from the Company after completion of 5 years of Service. The cost is to be borne by the Company and not by an employee. hence, unlike other fringe benefits (i.e. Medical Insurance, Term Insurance & Accidental Insurance) it can not be part of CTC.

To understand this, let us take an Example,

Mr. A Joins the Organization with a Basic Pay of Rs. 26,000/- per month and monthly CTC of 50,000/-. Assuming that expected increase in basic salary is assumed to be 10% p.a.

Now Gratuity Payments for next 5 years will be :-

On Completion of 1 Yr – (15/26)* 28,600*1 = 16,500/-
On Completion of 2 Yrs – (15/26)*31,460*2 = 36,300/-
On Completion of 3 Yrs – (15/26)*34,606*3 = 59,895/-
On Completion of 4 Yrs – (15/26)*38,067*4 = 87,847/-
On Completion of 5 Yrs – (15/26)*41,873*5 = 1,20,788/-

Now for making the payment of gratuity, Company has 2 options :

(i) Pay as you go option – Where company makes a provision of Gratuity in the Balance Sheet on the accrual basis taking an actuarial report on BS date from an Actuary and as and when Mr. A leaves the organization, company pay gratuity from their resources and get the tax benefit for the gratuity paid.

Expected Tax Benefit calculation in case of “Pay as you Go Option” :-

For Provision of 1st Yr – NIL
For Provision of 2nd Yr – NIL
For Provision of 3rd Yr – NIL
For Provision of 4th Yr – NIL
For Payment on 5th Yr – 1,20,788/-

In this case company, Mr. A will leave the company then company will get the tax benefit of Rs. 1,20,788/-.

(ii) Funding Option – In this option, Company decides to Setup an Approved Gratuity Trust . The Investment of Company is either “Self Managed ” or “ Managed by Insurance Company”. Company contribute the annual contribution in this Gratuity Trust and get the Tax Benefits. In this case, when Mr. A will leave the company, gratuity will be to Mr. A from the Gratuity Trust.

Expected Tax Benefit calculation in case of “Funding Option” under Section 36(1)(v) of the IT Act 1961 for Annual Contribution which is 8.33% of Annual Basic Salary of Employee.

For more details, you may visit my write up at https://www.citehr.com/609164-benefits-setting-up-gratuity-trust-companies.H T M L

We have provided consultancy for administration Gratuity Trust Fund in the various organization in all sectors of Indian Economy on receipt of their Management request and If you wish to know details like:-

1. Who can be covered under Gratuity Trust Fund?
2. How can companies administer Gratuity Trust and avail of the tax benefits?
3. Benefits to Employer,
4. Benefits to Employee,
5. Gratuity Trust Fund -Interpretation of Tax Implications.

We may also be contacted for the structuring of other Retention Schemes, Group Health Insurances, Group Terms Insurances, Group Annuity Plans, Group superannuation Plans, Property/Fire Insurances and investment in 100% risk-Free Government of India Bonds (GOI Bonds)

Tikaram Chaudhary (Founder of Gratuity Trust Fund Consultant) (2187 Points)
Replied 08 May 2019

I hope below write up may give more clarity on the provisions of Payment of Gratuity Act 1972 (Amended)”

Under the provisions of the Payment of Gratuity Act 1972 (Amended), gratuity is a statutory obligation on the shoulders of the employer to make the payment of Gratuity to his employees as soon as it becomes payable (Refer Sub Section (2) of Section 7 to the Act).

Applicability

Compliance of this act is applicable to all organizations such as a factory, mine, oilfield, port, railways, plantation, shops, establishments or Educational institution having 10 or more employees on any day in the preceding 12.

Determination of Gratuity Amount

The amount of Gratuity payable to an employee on his exit from service, according to “The Payment of Gratuity (Amendment) Act 2018 ”, in force at present, is:-

(Wages of the employee at the time of exit) x (15/26) x (Number of Years of Service at the time of exit)

This is subject to a ceiling limit of 20,00,000/- effective from 29.03.2018.

Conditions for payment of Gratuity

Gratuity is payable to an employee on exit from service after he has rendered continuous service for not less than five years:

(a) On his superannuation

(b) On his resignation

(c) On his death or disablement due to injury or disease.

In the case of (c) vesting condition of 5 years does not apply.

Gratuity Benefits depends upon the last drawn monthly wages and is linked to the length of service, normally it goes on increasing from the time when the employee joins service and the time of his exit from service

Provisions for Employer under Payment of Gratuity Act 1972 (Amended)”

Section 7 of the Act has kept obligation for payment of gratuity act on the shoulders of the employer, few provisions of the act are listed below:-

1. As soon as Gratuity becomes payable, it employers responsibility to determine the amount of gratuity and inform it to the employee in writing (Refer Sub-Section 2 of Section 7 of the Act).

2. The employer shall arrange to pay the amount of gratuity within 30 days from the date when it becomes mandatory. (Refer Sub-section 3 of Section 7 of the Act).

2. If the amount of gratuity is not paid within 30 days then the amount of gratuity and simple interest will be paid by the employer to the employee for the duration when the payment is not made to the employee. (Refer Sub-section 4 of Section 7 of the Act).

Accounting of Gratuity by the Employer

The Companies Act regulates/prescribes the Accounting Standard/Accounting Standards for the accounting of payment of Gratuity in the Financial Statements of different organizations. The compliance of Accounting Standard/standards is mandatory in nature.

The Institute of Chartered Accountants of India prescribes following Accounting Standard/standards for accounting of Gratuity by the companies:-

Accounting Standard 15 (Revised 2005)

Ind AS 19

For Accounting of Gratuity by Schools, The Institute of Chartered Accountant has issued Guidance note on Accounting by Schools (2005) or as amended at time to time.

Under the accounting preview, gratuity falls in the category of the defined benefit plan and is a post-retirement benefit. The nature of computation of post-retirement benefit is complex and hence Actuarial Valuation Certificate/ Report of an Actuary (Para 49 of AS 15 Revised 2005) forms the basis of accounting provisions of gratuity in the financial statement.

Income Tax Rules for Gratuity

Accounting provision of gratuity in Financial Statements/Balance Sheet is not allowed as a deduction under Section 40A(7) of Income Tax Act, 1961 (as amended time to time). The Section is produced below:-

“ (a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of Gratuity to his employees on their retirement or on termination of their employment for any reason.

(b) Nothing in clause (a) shall apply in relation to any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year.”

For gratuity payment management, the employer has the option to fund the liabilities for payment of gratuity by setting up an irrevocable trust approved in terms of part c of the fourth schedule to the income tax act, 1961.

The contributions made by the employer in such trust is allowed as a business expense under section 36 (1) (v) of the income tax act, 1961. This section is produced herein below:-

“ (a) any sum paid by any sum paid by the assessee as an employer by way contribution towards an approved gratuity fund created by him for the exclusive benefits of his employees under an Inrrecovable Trust.”

For more details in the above matter then you may contact us at 9211637063 or email your requirement at tikaramchaudhary @ gmail.com.

I have 10 years of experience in providing consultation and have a team of leading Finance professionals, Litigation Partners, Chartered Accountants, Company Secretaries & Heads of Insurance Companies. In my 10 years of experience I have given consultation to CFOs, Directors, Heads of HR, Finance and Tax Planning department of the Companies, spread in all sectors of the Indian Economy, in the Public & Private Sectors which covers areas of Manufacturing, Software, Technology, Electricity, Electronics, Call Centers, Banks, Educational Institutes, Schools, Universities, Hotels, Hospitals, Hospitality Companies, etc. etc.

We offer consultation for the following services:-

Consultation for Traditional and Unit Linked Group Gratuity Schemes.

o Traditional Group Gratuity Schemes of LIC

o Unit Linked Group Gratuity Schemes of Private Insurance Cos.

Consultation for Restructuring of Gratuity or Leave Encashment Policy.

o For Retention of Most Productive Employees.

o For Enhancement Productivity and Liability Management.

Consultation for all types of Business Valuations

o Actuarial Valuations

o Capital Gain Valuations

o Property Valuations

o Machinery Valuations

o Shares Valuations

Consultation for Employee Retention Schemes, Retirement Investment in Annuities, Marine Insurances, EAR Insurance, Corporate Property, and Fire Insurances.

Tikaram Chaudhary

Group Gratuity Trust Fund Consultant

Office Address : R 11, F/F, R Block, Vikas Nagar, New Delhi -110059

Mobile Number : 9211637063

Email Id : gratuityconsultant @ gmail.com

Blog: https://gratuityconsultant.blogspot.com

Website: https://gratuity-trust-fund-consultant-in-delhi-ncr.business.site/

LinkedIn Profile : https://www.linkedin.com/in/tikaram-chaudhary-a5727848/

(All Consultancy Services provided by us are subject to terms & conditions will be stated when a consultation job is accepted.)

Tikaram Chaudhary (Founder of Gratuity Trust Fund Consultant) (2187 Points)
Replied 30 January 2021

Requirement Of Gratuity Trust Fund Consultant For Matter Related To Gratuity Trust, Gratuity Fund, Gratuity Investment, Gratuity Trust Approval & Gratuity Scheme Approval. For more details visit :-

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