1. Brief about Gratuity Benefit
Gratuity being
an important retirement benefit to employees in the Indian context, is relevant
for all organizations (i.e. MNC’s, Schools and Other business entities) having
more than 10 employees. Since an employee sacrifices prime time of his life for
the development, prosperity and betterment of his employer, employer pays his
employee gratuity as a graciousness or gift to him, when he no longer serves
him. 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).
2.
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 months.
3.
Determination of Gratuity Amount
(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.
4.
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.
5. Factors
affecting Gratuity Benefits
Gratuity
Benefits changes with the change in the following:-
(a) Past Service
of Employee in the Company,
(b) Increase in
wages of Employee in the Company,
(c) Change in
Benefit Formula of the Gratuity Benefit due to the amendment in the Act,
(d) Change in
Ceiling Limit on Gratuity Benefits due to the amendment in the Act,
(e) Change in
Vesting Condition for eligibility of Gratuity Benefits due to the amendment in
the Act,
6. The
impact of the above Factors on Gratuity Benefits can be understood by the
following Examples :
(a) Change
Past Service of Employee in the Company.
Mr. A Joins the
Company with a Basic Pay of Rs. 2,60,000/- per month and there is no change in
basic salary, only his Past Service Change then Gratuity Payments for the next
5 years will be:-
On Completion of
1 Yr – (15/26)* 2,60,000*1 = 1,50,000/-
On Completion of
2 Yrs – (15/26)*2,60,000*2 = 3,00,000/-
On Completion of
3 Yrs – (15/26)*2,60,000*3 = 4,50,000/-
On Completion of
4 Yrs – (15/26)*2,60,000*4 = 6,00,000/-
On Completion of
5 Yrs – (15/26)*2,60,000*5 = 7,50,000/-
The above
amounts are subject to Ceiling Limits on Gratuity Benefits applicable.
(b)
Increase in wages of Employee in the Company.
Mr. A Joins the
Company with a Basic Pay of Rs. 2,60,000/- per month and there is the change in
wages @ 10%, then Gratuity Payments for the next 5 years will be :-
On Completion of
1 Yr – (15/26)* 2,86,000*1 = 1,65,000/-
On Completion of
2 Yrs – (15/26)*3,14,600*2 = 3,63,000/-
On Completion of
3 Yrs – (15/26)*3,46,060*3 = 5,98,950/-
On Completion of
4 Yrs – (15/26)*3,80,670*4 = 8,78,460/-
On Completion of
5 Yrs – (15/26)*4,18,730*5 = 12,00,788/-
The above
amounts are subject to Ceiling Limits on Gratuity Benefits applicable.
(c) Change
in Benefit Formula of the Gratuity Benefit due to the amendment in the Act.
Mr. A Joins the
Company with a Basic Pay of Rs. 2,60,000/- per month, His increment in wages @
10%, and due to change in the Gratuity Factor as 1/1 from 15/26 then Gratuity
Payments for next 5 years will be :-
On Completion of
1 Yr – (1/1)*2,86,000*1 = 2,86,000/-
On Completion of
2 Yrs – (1/1)*3,14,600*2 = 6,29,200/-
On Completion of
3 Yrs – (1/1)*3,46,060*3 = 10,38,180/-
On Completion of
4 Yrs – (1/1)*3,80,670*4 = 15,22,660/-
On Completion of
5 Yrs – (1/1)*4,18,730 *5 = 20,93,660/-
The above
amounts are subject to Ceiling Limits on Gratuity Benefits applicable.
(d) Change
in Ceiling Limit on Gratuity Benefits due to the amendment in the Act.
Mr. A Joins the
Company with a Basic Pay of Rs. 5,00,000/- per month, His increment in wages @
10%, and due to changes in Ceiling Limit from 10 Lakhs to 20 Lakhs then
Gratuity Payments for the next 5 years will be:-
Case 1 –
When Ceiling Limit on Gratuity Payment is 10,00,000/-
On Completion of
1 Yr – (15/26)* 5,50,000*1 = 3,17,308/-
On Completion of
2 Yrs – (15/26)*6,05,000*2 = 6,98,077/-
On Completion of
3 Yrs – (15/26)*6,65,500*3 = 11,51,827/- Company liable to pay 10,00,000/-
On Completion of
4 Yrs – (15/26)*7,32,050*4 = 16,89,346/- Company liable to pay 10,00,000/-
On Completion of
5 Yrs – (15/26)*8,05,255*5 = 23,22,851/- Company liable to pay 10,00,000/-
Case 2 –
When Ceiling Limit on Gratuity Payment is 20,00,000/-
On Completion of
1 Yr – (15/26)* 5,50,000*1 = 3,17,308/-
On Completion of
2 Yrs – (15/26)*6,05,000*2 = 6,98,077/-
On Completion of
3 Yrs – (15/26)*6,65,500*3 = 11,51,827/-
On Completion of
4 Yrs – (15/26)*7,32,050*4 = 16,89,346/-
On Completion of
5 Yrs – (15/26)*8,05,255*5 = 23,22,851/- Company liable to pay 20,00,000/-
Case 3 –
When Ceiling Limit on Gratuity Payment is 30,00,000/-
On Completion of
1 Yr – (15/26)* 5,50,000*1 = 3,17,308/-
On Completion of
2 Yrs – (15/26)*6,05,000*2 = 6,98,077/-
On Completion of
3 Yrs – (15/26)*6,65,500*3 = 11,51,827/-
On Completion of
4 Yrs – (15/26)*7,32,050*4 = 16,89,346/-
On Completion of
5 Yrs – (15/26)*8,05,255*5 = 23,22,851/-
(e) Change
in Vesting Condition for eligibility of Gratuity Benefits due to the amendment
in the Act.
In the above
examples for (a) to (d), If an employee leaves the company before completion of
5 years then “Nil” gratuity benefit is payable in the following events :
(a) on his superannuation,
or
(b) on his
retirement or resignation.
Case 1 – When Vesting Condition for eligibility is 3 years, Company
will be liable to pay gratuity benefit on completion of 3 years in event of his
superannuation, on his retirement or resignation.
Case 2 – When Vesting Condition for eligibility is 2 years, Company
will be liable to pay gratuity benefit on completion of 2 years in event of his
superannuation, on his retirement or resignation.
Case 3 – When Vesting Condition for eligibility is 1 year, Company
will be liable to pay gratuity benefit on completion of 1 year in event of his
superannuation, on his retirement or resignation.
Section 7 of the
Act has kept obligation for payment of gratuity act on the shoulders of
employer, few provisions of this section act are listed below:-
1. As
soon as Gratuity becomes payable, it employers responsibility to determine the
amount of gratuity and inform it to 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).
3. If
the amount of gratuity is not paid within 30 days then 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).
4. Applicability of compulsory insurance for Gratuity by State
Governments due amendment in the act. (State of Andhra Pradesh
notified about the compulsory insurance for Gratuity under Andhra Pradesh Compulsory Gratuity Insurance
Rules, 2011 vide Lr.No.M1/8842/2010, dated: 04.12.2010 from the
Commissioner of Labour, Andhra Pradesh and remains un-notified for rest of
India). Applicability of compulsory insurance for Gratuity can be
notified by the other State Governments because compulsory insurance of
gratuity secures the gratuity benefits of employee even in case of bankruptcy
of the company.
8. Options
for Gratuity Benefits Management to Companies
From point
No. 5, 6 & 7, we conclude that the Gratuity Liability of companies increase
exponentially with the increase in wages of employee, service period of
employee, regulatory changes as shown in point 6 and it is employers
responsibility to pay the gratuity to employee to avoid the regulatory penalty
for Non Payment of Gratuity within stipulated time as given in 7 (2) above. Employers generally have 2 options for discharging the
Gratuity Liability: –
1. Pay as
go options – In this option, the
Companies makes provision of Gratuity Liability by taking an Actuarial
Valuation Report/Certificate from Actuary (Para 49 of AS 15
Revised 2005) to Comply with the requirements of following Accounting
Standards issued by the Institute of Chartered Accountants of India :-
a. AS 15
(Revised 2005)
b. IndAS 19
c. IAS 19
(Revised 2011)-IFRS
In Indian context,
Companies falls in following three categories based on the basis of compliance
criteria mentioned in Accounting Standards :-
(i)
SME – In this case, company needs to disclose
details as required for Clause (l) of Para 120 of AS 15 (Revised 2005)
(ii) Non –
SME – In this case, company needs to disclose details as
required for Para 120 of AS 15 (Revised 2005)
(iii)
Companies with Net-worth more 250 cr. – In this
case, companies and their subsidiaries has to give disclosure of in compliance
of IndAS 19 with comparative numbers of previous 2 years.
Taxation
of Gratuity Payment under Pay as go options :-
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.
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,
Expected Tax Benefit calculation in case of “Pay as you Go Option” is as under
:-
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/-.
2. 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 Contribution
of 1st Yr – 28,600*12*0.833 = 28,589/-
For Contribution
of 2nd Yr – 31,460*12*0.833 = 31,447/-
For Contribution
of 3rd Yr – 34,606*12*0.833 = 34,592/-
For Contribution
of 4th Yr – 38,067*12*0.833 = 38,051/-
For Contribution
of 5th Yr – 38,067*12*0.833 = 41,857/-
In this
case, Mr. A will get gratuity of Rs. 1,20,788/- from the Gratuity Trust and
employer will get approximate Tax Benefits of Rs.1,74,536/- for annual
contribution made by him in previous 5 years.
To get more
clarity on the above example, let us take some more questions about the
possibilities/event that may happen on or after completion of 5 years and their
impact on the Company in case of “Funding Option” :-
Question
1. If employee died during 1st to 4th year before completion of 5th year, then
what would be the benefit for Company and employee’s Nominee ?
Answer 1.
If employees died after 1 yr, 2nd, 3rd and 4th year but before completion of
5th year, then the company will get tax benefits for the following
contributions:-
For Contribution
of 1st Yr – 28,600*12*0.833 = 28,589/-
For Contribution
of 2nd Yr – 31,460*12*0.833 = 31,447/-
For Contribution
of 3rd Yr – 34,606*12*0.833 = 34,592/-
For Contribution
of 4th Yr – 38,067*12*0.833 = 38,051/-
The company will
get the Tax for the contribution made by him before the date of death of the
employee as stated above and employee’s nominee will get following Gratuity
Payments from the Trust along with a future service gratuity subject to certain
limits as defined by the Insurance Company whilst taking Group Gratuity Scheme
from the Insurance Company.
Question
2. If the employee resigns during 1st to 4th year and before completion of 5th
year, then what would be the benefit for Company and employee?
Answer 2.
If employees resign during 1st to 4th year and before completion of 5th year,
then the company will get tax benefits for the following contributions:-
For Contribution
of 1st Yr – 28,600*12*0.833 = 28,589/-
For Contribution
of 2nd Yr – 31,460*12*0.833 = 31,447/-
For Contribution
of 3rd Yr – 34,606*12*0.833 = 34,592/-
For Contribution
of 4th Yr – 38,067*12*0.833 = 38,051/-
For Contribution
of 5th Yr – 38,067*12*0.833 = 41,857/-
and the employee
will not get following Gratuity Payment from the Trust. The amount contributed
by the company and interest accrued will be used by the trust for future
payments of Gratuity to other employees of the company.
Question
3. If the employee resigns/retires after completion of 5th year, then what
would be the benefit for Company and employee?
Answer 3.
If employees resigns/retires during after completion of 5th year, then the
company will get tax benefits for the following contributions:-
For Contribution
of 1st Yr – 28,600*12*0.833 = 28,589/-
For Contribution
of 2nd Yr – 31,460*12*0.833 = 31,447/-
For Contribution
of 3rd Yr – 34,606*12*0.833 = 34,592/-
For Contribution
of 4th Yr – 38,067*12*0.833 = 38,051/-
For Contribution
of 5th Yr – 38,067*12*0.833 = 41,857/-
Total
Contribution in 5 years………………………= Rs.1,74,536/-
and the employee
will get Rs. 1,20,788/- as Gratuity Payment from the Trust. Since the company
has contributed an amount in the trust is more then what is payable after 5th
year so the surplus amount and interest accrued on the contributions of will be
used by the trust for payment to the other employees.
9. Why
Funding Option is preferred by Companies for Gratuity Benefits Management
Mostly companies
prefer funding option for management Gratuity Benefits of the employees due to
following reasons :-
1. For Tax
Benefits :- Gratuity provision based on
the Actuarial Valuation Report received from Actuary is required by the
company for compliance of Para 133 of the Companies Act 2013 for preparation of Financial Statement to comply with the
requirement of Accounting Standard 15 (Revised 2005) but it 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.”
Few
Benefit of Creating an Approved and Registered Gratuity Trust are as under :-
1.
Taxation Benefits
I. Initial Contribution based on actuarial report (Refer
Circular : No. 30(XLVII-18), dated 30-11-1964 for clarification for Rule
103 for Initial Contribution of Income Tax Rules 1962) made by the
Companies is treated as a annual expense for Income Tax Computation of
the Company (Refer Section 36(1)(v) of Income
Tax Act 1961. Section 36(1)(v) of Income Tax Act, 1961 reads as under
:-
“any sum
paid by the assessee as an employer by way of contribution towards an approved
gratuity fund created by him for the exclusive benefit of his employees under
an irrevocable trust”
II. Annual Contribution an amount equal to 8.33% of basic salaries
can be paid into a gratuity fund as a tax-deductible expense.
III. Interest or investment income earned within the gratuity fund is
also tax-free.
2. For
Risk Management of Gratuity Benefits of Employees even in case of Financial
Crisis
3.
Liquidity management.
4.
Cash-flow stability
10. Steps
Involved in Formation of Trust for Gratuity Fund
In this section
my article we will discuss about the steps involved in Formation of Trust for
Gratuity Fund. The different steps for Formation of Retirement Benefit
Trust are as under :-
1. Assessment
of Gratuity Liability.
2. Board
Resolution for an Approved Gratuity Trust.
3.
Registration of Trust Deed & Trust Rules.
4.
Investment Decision.
5.
Application for Approval of Gratuity Trust.
For more details in the above matter you may contact me at
tikaramchaudhary@gmail.com or call me at 9211637063.We have our associates in
Mumbai to undertake the complete assignment for Formation of Gratuity,
Leave Encasement, Superannuation & Pension Trust.
Tika Ram Chaudhary
Gratuity Trust
Fund Consultant
(Corporate
Consultant with more than 11 Years of experience in providing Support Services
to Indian and Multinational Companies for Formation of Gratuity Trust,
Formed to gain Tax Benefit available for Companies under Section 36 (1) (v) of
Income Tax Act 1961 & Specialized Support Services for preparation of
Inputs for Actuarial Valuations in compliance of AS 15 (Revised 2005), IndAS
19, IAS 19 (Revised 2011) - IFRS & USGAAP required by Gratuity Trust of Indian
Companies)
Registered Office
Address: R 11, F/F, R Block, Vikas Nagar, Uttam
Nagar, New Delhi -110059
Mobile Number: 9211637063
(All
services/consultancy is subject to terms and conditions)
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