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The Payment of Gratuity (Amendment) Act 2018 provides a Financial Security to Employees working in all organizations such as factory, mine, oilfield, port, railways, plantation, shops, having 10 or more employees on any day in the preceding 12. 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 employment injury or disease.
In case of (c) vesting condition of 5 years does not apply.
The amount of Gratuity payable to an employee on his exit from service, according to “ Payment of Gratuity Act 1972”, in force at present, is :-
(Salary 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/-.
Normally, Companies have two options for payment of Gratuity Liability in their Accounting ,
(i) “Pay as you go option” - Where company makes a provision of Gratuity in the Balance Sheet on the accrual basis and as and when any person leaves the organization, they pay Gratuity from their company resources and Get the Tax Benefit for the gratuity paid.
(ii) “Funding Option” - In this option, Company takes a board resolution and deputes trustees and trustees create a Gratuity Fund. The trustees either Manage the
Trust “Privately” or “Through Insurance Company”.
Trustees of the Gratuity Fund prefer to manage the Gratuity Fund through Insurance Company as a liability on account of gratuity experiences sharp increase every year due to the nature of its computation. Apart from an increase in service, an increase in salary also contributes to increase in liability substantially as the benefits are payable on the last drawn salary. Hence funds have to be invested in a conservative way with consistent growth and insulated from market risks.
Mostly Trustees, prefer Life Insurance Corporation of India (LIC) as Funds invested with the Corporation (LIC) enjoy SOVERIGN GUARANTEE of Central Government of India and the same is expressly provided under Section 37 of the LIC of India Act, 1956, passed by none other than Parliament of India, i.e. 100% security of Funds invested with LIC. LIC’s Scheme of GROUP GRATUITY is an approved pattern of investment (Ref: Rule 101, Income Tax Rules, 1962.), hence there are no complications from income Tax/ Legal point of view.
The unique advantage with LIC is the contributions made by the company and interests credited by LIC are irreversible. This ensures highest level of safety for the total corpus and consistency in future contributions. As the gratuity payments are statutory and LIC gratuity scheme being the only investment tool which enjoys sovereign guarantee, gives a greater comfort to employer.
Besides the above-said advantages, the scheme also provides for employee welfare measures with built-in insurance cover, which provides insurance coverage to the employees to the tune of future service gratuity subject to certain limits. The insurance cover can be flexible depending on the requirements of the Trust. The Group Insurance premium will be commensurate to the cover provided.
An employee joined the service at age -25 years
Retirement age - 60 years
Death at age- 35 years
Anticipated service - 25 years
Salary at the time of death - Rs.10000/-per month
Gratuity on the accured basis - Rs. 57692/- approx
Gratuity on anticipated basis - Rs.2,01,923/- (accrued Gratuity plus life cover of Rs. 1,44,231/- approx)
Tax Benefit for Creating Gratuity Fund with Insurance Company
Tax Benefit on Initial Contributions/ Annual Contributions : Under section 36(1)(v) of the Act, any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the benefit of his employees under an irrevocable trust is allowable as a deduction in the computation of income from business/profession. Such contribution however shall not exceed 81/3 per cent of the employees’ salary for each year of his past service with the employer in case of Initial Contributions & shall not exceed 81/3 per cent of the salary of each employee during each year in case of Annual Contributions.
Tax Benefit on Income of an approved Gratuity Fund : Income of an approved gratuity fund is exempt under Section 10(25)(iv).
Taxability of gratuity in the hands of employees : Gratuity payable to an employee is taxed as part of the employee’s salary income under Section 17 (i) (iii). However, Gratuity is tax free up to half months’ (15/26 of last drawn salary for each year of service for employees covered by payment of gratuity Act) average salary of last 10 months for each completed year of service, subject to a maximum of Rs. 20, 00,000 (in both cases) under Section 10(10).
Tax Benefit on Insurance Premium for Insurance cover for future service gratuity
The insurance premium paid towards the above said benefits is treated as deductible business expenses to the company. The premium is not treated as perks in the hands of the employees.
To more about : -
Steps Involved in Creating a Gratuity Trust with Insurance Company, Process of Approval of Gratuity Trust from Income Tax Commissioner, Employee Data Format to be submitted by the company to Insurance Company for Group Gratuity Scheme, Critical issues & Features of Group Gratuity Scheme of LIC, Income Tax Return of Approved Gratuity Fund.
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This post is an attempt to give a brief about Impact of increase in Salary and Past Service on Gratuity Payments and requirement of Gratuity Trust Fund to meet .
Gratuity benefits are governed by  "The Payment of Gratuity Act 1972" and paid by the employer 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 case of (c) vesting condition of 5 years does not apply.
Liability on account of gratuity experiences sharp increase every year due to the nature of its computation. Apart from an increase in service, an increase in salary also contributes to increase in liability substantially as the benefits are payable on the last drawn salary.
For Example,
Gratuity Liability of an employee of 35 yrs. with basic salary as Rs, 26,000/- and have completed 5 years of Past service as on 31.03.2018 will be :-
 (15/26)*26000*5
= 75,000/-
Case 1
Gratuity liability with Increase of 1 year past service and without any increment in Basic Salary.
Gratuity Liability of an employee of 36 yrs. with basic salary as Rs. 26,000/- and have completed 6 years of Past service as on 31.03.2019 will be :-
 (15/26)*26000*6
= 90,000/-
Case 2
Gratuity liability with Increase of 1 year past service & 5% increment in Basic Salary (i.e. 26000*1.05 = 27300/-)
Gratuity Liability of an employee of 36 yrs with basic salary as Rs. 27,300/- and have completed 6 years of Past service as on 31.03.2019 will be :-
 (15/26)*27300*6 = 94,500/-
Gratuity Liability on retirement in 31.03.2043 with 5% increment in Basic Salary {i.e. 26000*(1.05^25) = 88045/-}
Gratuity Liability of this employee on retirement at age 60 yrs with basic salary as Rs. 88,045/- with 30 years as on 31.03.2043 will be :-
 (15/26)*88045*30 = 15,23,860/-
From above example, it is clear that with a small change of 5.00% in basic salary, increases the gratuity liability by 1.26times in 1 year. Similarly 5% increase over next 25 yrs in Basic Salary will increase the gratuity liability 20.32 times which is payable on 31.03.2018 . Hence it becomes mandatory for employer to start investing in Gratuity Fund with consistent growth and insulated from market risks.
To know more about : -
1. Steps Involved in creating a Gratuity Fund,
2. How to use Gratuity Fund as Retention Tool for curbing the attrition rate,
3. Quantum of Income Tax Benefits of creating Gratuity Fund,
4. Steps Involved  Approval of Gratuity Trust Fund from competent Authority,
5. Critical issues & Features of Group Gratuity Schemes of Insurers
Great article. show me many tax benefits when creating bonus funds. I appreciate your article.
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