Analysis of Retirement benefit (Gratuity)

[Submitted by CA. Sachin Jain,
New Delhi]

March 14, 2008

Meaning :-

Gratuity is a statutory benefit paid to the employees under the Payment of Gratuity Act, 1972 who have rendered continuous service for at least five years. The employee is eligible for 15 days (15/26) of pay for each completed year of service. The employer can also structure a gratuity benefit that is higher than statutory requirements. The gratuity benefit is payable on cessation of employment (either by resignation, death, retirement or termination, etc) by taking the last drawn salary as the basis for the calculation.

Reason for Gratuity :-

Gratuity payment liability tends to increase as the salaries and tenure of employment increase annually. An employer may pay out gratuity proceeds from his current revenue, however, to ascertain the gratuity liability of the employer and for more prudent financial planning, it is beneficial to set up a gratuity fund.

Meaning of salary/Wages :-

As per payment of Gratuity Act, 1972, Salary/Wages includes all emoluments earned by the employee while on duty or on leave, including DA, but does not include Bonus, Commission, HRA, Over time & any another allowance.

Applicability :-

• Every factory (as defined in Factories Act), mine, oil field, plantations, port and railway company.
• Every shop or establishment to which Shop & Establishment Act of a state applies in which 10 or more persons are employed on any day of the preceding 12 months.
• Any establishment employing 10 or more persons as may be notified by the Central Government.

Who Gets the benefit of Gratuity :-

• Any person employed on wages/Salary (other than apprentice).
• At the tine of retirement / resignation/on superannuating, an employee should have rendered continuous service of not less than 5 years.
• In case of death or disablement, the gratuity is payable, even if he has not completed 5 years of service.

Exp. Deduction in Income Tax :-

As Per Section 36 (1)(v) of Income Tax Act, 1961 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.

Expenses or payments not deductible in certain circumstances:-

As per section 40A (7) (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.

Clause (b) of Section 40A(7) 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.

Certain deductions to be only on actual payment:-

According Section 43B of Income Tax Act, 1961 any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuating fund or gratuity fund or any other fund for the welfare of employees is allowed as deduction.

Incomes not included in total income: -

As per section 10 of Income Tax Act,1961 ,In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included

1. any death-cum-retirement gratuity received under the revised Pension Rules of the Central Government or, as the case may be, the Central Civil Services (Pension) Rules, 1972, or under any similar scheme applicable to the members of the civil services of the Union or holders of posts connected with defence or of civil posts under the Union (such members or holders being persons not governed by the said Rules) or to the members of the all-India services or to the members of the civil services of a State or holders of civil posts under a State or to the employees of a local authority or any payment of retiring gratuity received under the Pension Code or Regulations applicable to the members of the defence services ;
    
2. any gratuity received under the Payment of Gratuity Act, 1972 (39 of 1972), to the extent it does not exceed an amount calculated in accordance with the provisions of sub-sections (2) and (3) of section 4 of that Act ;
    
3. any other gratuity received by an employee on his retirement or on his becoming incapacitated prior to such retirement or on termination of his employment, or any gratuity received by his widow, children or dependants on his death, to the extent it does not, in either case, exceed one-half months salary for each year of completed service, [calculated on the basis of the average salary for the ten months immediately preceding the month in which any such event occurs, subject to such limit as the Central Government may, by notification in the Official Gazette, specify in this behalf having regard to the limit applicable in this behalf to the employees of that Government] :
    
   Provided that where any gratuities referred to in this clause are received by an employee from more than one employer in the same previous year, the aggregate amount exempt from income-tax under this clause [shall not exceed the limit so specified] :
    
   Provided further that where any such gratuity or gratuities was or were received in any one or more earlier previous years also and the whole or any part of the amount of such gratuity or gratuities was not included in the total income of the assessee of such previous year or years, the amount exempt from income-tax under this clause [shall not exceed the limit so specified] as reduced by the amount or, as the case may be, the aggregate amount not included in the total income of any such previous year or years.
    
   Explanation. [In this clause, and in clause (10AA)], salary shall have the meaning assigned to it in clause (h) of rule 2 of Part A of the Fourth Schedule ;]
    
4. any income received by the trustees on behalf of an approved gratuity fund;\

Meaning of Approved Gratuity Fund :-

Approved gratuity fund means 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

How to Installed Approved Gratuity Fund :-

• Pass a resolution for creation for Gratuity Trust Fund.
• Execute the Trust Deed and appoint Trustees for administering the scheme. If Trust already exists, execute a Deed of Variation.
• Apply to Commissioner of Income Tax for approval under Part C of the Fourth Schedule of the Income Tax Act, 1961
• Forward to LIC, Master Proposal signed by Turstees, employee data, copies of Trust Deed, Scheme Rules and cheque for payment of premium.
• Open a bank account in favour of the Trust.

Conditions for approval :-

In order that a gratuity fund may receive and retain approval, it shall satisfy the conditions set out below and any other conditions which the Board may, by rules, prescribe under Fourth Schedule Part - C of Income Tax Act,1961

1. the fund shall be a fund established under an irrevocable trust in connection with a trade or undertaking carried on in India, and not less than ninety per cent of the employees shall be employed in India ;
    
2. the fund shall have for its sole purpose the provision of a gratuity to employees in the trade or undertaking on their retirement at or after a specified age or on their becoming incapacitated prior to such retirement or on termination of their employment after a minimum period of service specified in the rules of the fund or to the widows, children or dependants of such employees on their death ;
    
3. the employer in the trade or undertaking shall be a contributor to the fund ; and
    
4. all benefits granted by the fund shall be payable only in India.

Application for approval :-

An application for approval of a gratuity fund shall be made in writing by the trustees of the fund to the [Assessing] Officer by whom the employer is assessable and shall be accompanied by a copy of the instrument under which the fund is established and by two copies of the rules [and, where the fund has been in existence during any year or years prior to the financial year in which the application for approval is made, also two copies of the accounts of the fund relating to such prior year or years (not being more than three years immediately preceding the year in which the said application is made)] for which such accounts have been made up, but the [Chief Commissioner or Commissioner] may require such further information to be supplied as he thinks proper.

Liability of trustees on cessation of approval :-

If a gratuity fund for any reason ceases to be an approved gratuity fund, the trustees of the fund shall nevertheless remain liable to tax on any gratuity paid to any employee.

Contributions by employer, when deemed to be income of employer :-

Where any contributions by an employer (including the interest thereon, if any) are repaid to the employer, the amount so repaid shall be deemed for the purposes of income-tax to be the income of the employer of the previous year in which they are so repaid.

Threshold Exemption Limit :-

Up to Rs. 3,50,000 Amount is Exempt under section 10(10) and above these its taxable in Income Tax Act, 1961

Conclusion :-

Every Company should Create an approved Gratuity Trust with the permission of Income Tax officer specified under Schedule Forth of Part C of Income Tax Act,1961. The advantage of these fund that the Amount contributed under these fund is allowed expenditure and the company can secured his further liability just make a contribution with the Approved Trust (i.e. LIC , ICICI etc.) The above policy is for the benefit of all the employees and when they retired from his job he get a lump-sum amount on account of retirement benefit for pass throw his remaining life as self dependent.

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