1. Brief about Gratuity Benefit
Gratuity being an important retirement benefit to employees in the Indian context, is relevant for all organizations (i.e. Companies, NBFC's, Financial Institutions, 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
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.
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. 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 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).
7. Options available to Companies for Discharging the Gratuity Liability
From point No. 5 & 6, 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 6 (2) above. Employers generally have 2 options for discharging the Gratuity Liability: –
1. Accounting Option also called “Pay as you go” Option
2. Funding Option
7(a). Accounting Options
Accounting Option – Under this option provision of gratuity is made in Financial Statement of the Company by taking Actuarial Valuation Report from the Actuary and when employee leaves the company employee, employer pays the gratuity from their own resources. This option is called "Pay as you go Option". This is mandatory for all companies having 10 or more companies. Few more points to be considered by the Auditors whilst Auditing the Financial Statement in respect of Accounting of Gratuity Benefits are as under :-
1. As per provisions of Section 129 of the Companies Act 2013, each company has to prepare the Financial Statement such as Balance Sheet & Profit/Loss Accounts at the closure of each financial year in compliance of Accounting Standards as stipulated in Section 133 of the Companies Act 2013, so that they can give a true and fair view of state of affairs of the company. MCA vide its notification dated 13th November 2018 notified National Financial Reporting Authority (NFRA) Rules 2018. The main functions NFRA Authority are:-
A. Monitoring and enforcing the
B. Overseeing the quality of Audit service and suggesting measures for improvement,
C. Power to investigate,
D. Disciplinary proceedings, Manner of enforcement of orders passed in disciplinary proceedings,
In view of above provisions, it becomes mandatory for Professionals (i.e.CA, CS, CMA, Finance Professionals & Directors) involved in finalization of Financial Statements to check the proper compliance and provisions of these Accounting Standards.
In Indian context, Companies needs Actuarial Services for Compliance of following Accounting Standards for Accounting of Defined Benefit Plans (i.e. Gratuity Plan, Leave Encashment Plan, Pension Plan, PRMB etc.). Accounting and Disclosure requirements for Employee Benefits Plans as laid down in the following Accounting Standards as issued by The Institute of Chartered Accountants of India (ICAI):-
1. Accounting Standard 15 (Revised 2005) – AS 15 (Revised 2005)
2. Indian Accounting Standard 19 – IndAS 19
The main objectives of the above Standards to prescribe the guidelines and disclosures for Accounting for Defined Benefit Plans (i.e. Gratuity, Leave Encashment, Pension etc.). In order to comply with above standards a company is required to recognize:-
(a) a liability when an employee has provided service to company in exchange for defined benefits to be paid in the future; and
(b) an expense when the company consumes the economic benefit arising from service provided by an employee in exchange for defined benefits.
Accounting for defined benefit plans is complex because actuarial assumptions are required to measure the obligation and the expense and there is a possibility of actuarial gains and losses. Moreover, the obligations are measured on a discounted basis because they may be settled many years after the employees render the related service. While the Standard requires that it is the responsibility of the reporting enterprise to measure the obligations under the defined benefit plans, it is recognized that for doing so the enterprise would normally use the services of a qualified actuary.
Auditors follow the following criterion to know the applicability of Accounting Standards and disclosure requirement by the Companies :-
(i) SME Companies – In this case, company needs to disclose details as required for Clause (l) of Para 120 of AS 15 (Revised 2005)
(ii) Non SME Companies – In this case, company needs to disclose details as required for Para 120 of AS 15 (Revised 2005)
(iii) Listed Companies & their subsidiaries with Net-worth more 250 cr. – In this case, companies and their subsidiaries has to give disclosure of in compliance of IndAS 19.
(iv) NBFC (Non-Banking Financial Company) with Net-worth more 250 cr. – In this case, NBFC has to give disclosure of in compliance of IndAS 19 with comparative numbers of previous 2 years.
7(b). Funding Option
Funding Option –In this option, Companies make provision of Gratuity liability in the balance on annually on accrual basis based on actuarial report but it is not allowed as deduction whilst computing net Income of Income Tax (Refer Section 47A (7) of Income Tax Act 1961), So companies prefer to create Gratuity Trust. There are 2 major benefits to the company by creating an Irrevocable Trust:-
(i) Contribution into Approved Trust is allowed as deductible Expense - Provision of Gratuity Liability shown in the Balance Sheet is not allowed as deduction whilst computing net Income for Income Tax ((Refer Section 47A (7) of Income Tax Act 1961)) whereas Initial and Annual Ordinary Contribution made by company into an Approved Gratuity Trust (Subject to condition specified in Income Tax Rules 103 & 104) is allowed as deductible expense under Section 36 (1) (v).
(ii) Interest received from Investment of an Approved Gratuity Trust is also exempted as Income Tax :- Interest received from Investment of an Approved Trust is also exempted as Income under Section 10 (25) (iv) of the Income Tax Act, 1961.
7(c). Examples for Taxation Benefits under Accounting and Funding Option
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 contributes the annual contribution in this Gratuity Trust and gets 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.
For more details in the matter you may visit my published article on www.taxguru.in at following weblink :- https://taxguru.in/income-
The establishment of Gratuity Trust & compliance of AS 15 (Revised 2005) & IndAS 19 requires in-depth knowledge of various rules/regulations and expertise. We have a Team of Leading Professionals, Litigation Partners, Chartered Accountants, Company Secretaries & Heads of Insurance Companies having decades of experience in providing services to our clients 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 have more than 11 years of experience in providing Consultancy and
Consultancy Services for Formation of Gratuity Trust for Gratuity Benefits
1. Formation of a New Approved Irrevocable Gratuity Trust.
2. Investment of Trust Money as per Income Tax Rules 1962.
3. Gratuity Trust Deed, Trust Rules, Applications.
4. Approvals of Trust in terms of Part C of Schedule IV from Income Tax Department in following cases :-
o Approvals for New Gratuity Trust or Group Gratuity Scheme
o Approvals for Change in Trust Deed
o Approvals for Change in Trust Rules
o Approvals for Change in Object of Trust
o Approvals for Change in Trustees
o Approvals for winding up of Trust due to winding up of the Company
o Approvals for amalgamation with another fund due to merger/acquisition of the Companies
5. Investment of Trust Money in Group Gratuity Schemes of Insurers.
· Traditional Group Gratuity Schemes of LIC
· Unit Linked Gratuity Schemes of Insurance Companies
Services Offered by our Professional Associates for Accounting of Gratuity Benefits
6. Actuarial Valuations in compliance of following Accounting Standards:-
o AS 15 (Revised 2005)
o IndAS19
o IAS 19 (Revised 2011)
o USGAAP
The services offered by us may be needed by you or by your clients:-
I. For compliance of AS 15 (Revised 2005) & IndAS19 whilst preparing the Balance Sheet and Profit/Loss Statement as stipulated in Section 133 of the Companies Act 2013, so that they can give a true and fair view of state of affairs of the Company.
II. For getting the Tax Benefits under Section 36 (1) (v) & Section 10 (25) (iv) of the Income Tax Act, 1961 by creating an Approved Gratuity Trust or by starting an Group Gratuity Scheme of Insurer before closure of Financial Year ending 31.03.2020.
Since annual financial statements such as Balance Sheet and Profit/ Loss Statement of your clients are at hand for the close of the financial year as on 31.03.2020, the services we deal in will be needed by many of your clients and we will be happy to provide our services if needed. In case of any clarification, you may contact me at 9211637063 or email me your queries at tikaramchaudhary@gmail.com.
Tika Ram Chaudhary
Gratuity, Pension, Superannuation 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)
Trade Name - Gratuity Trust Fund Consultant
Registered Office Address: R 11, F/F, R Block, Vikas Nagar, Uttam Nagar, New Delhi -110059
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