Gratuity & Leave Encashment Trust Fund
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Why Provisioning and Funding is Compulsory for Gratuity Benefits for companies with employee strength 10 or more "
1. Introduction
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
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 the completion of 5 years of Service. The cost is to be borne by the Company and not by an employee. 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.
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,
5. 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:-
i. 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).
ii. 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).
iii. 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).
iv. 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).
6. Why Provisioning and Funding is compulsory for companies with 10 or more employees ?
Gratuity Liability of companies increase exponentially with the increase in wages of employee, service period of employee, regulatory changes as shown in point 4 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 5 (ii) above.
For companies incorporated as per rules of Companies Act and having 10 or more employees need to prepare the Balance Sheet as per Guidelines of Section 133 of Companies Act 2013 every year and have 2 options for discharging the Gratuity Liability of their employees: -
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
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.
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.
7. Why Funding Options preferred by Companies ?
Gratuity Funding is compulsory 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). In case of funding there are 3 taxation benefits being available to companies :-
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.
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:- Once companies forms an Approved Gratuity Trust and starts making contribution into the trust then their vulnerability to making the default for Gratuity Payment to employees as per the Section 7 of the Payment of Gratuity Act 1972 is taken over by the Irrevocable trust subject to fund available with them. Since the Approved Gratuity Trust are Irrevocable, so the money contributed by the companies will be exclusively used for payment of Gratuity Benefits to the Employees and fund money can not be used by the company even in case of Bankruptcy.
3. Liquidity management :- If Gratuity Benefits are unfunded, companies will need to pay off the gratuities to leaving employees as and when they leave. Therefore, the amount companies would pay could vary greatly from year to year as the number of people leaving will be uncertain. This would be a particular concern for small or mid-size companies where the resignation of just a few senior employees, with high salary and service, could create a strain on their cashflow positions. On the other hand, if a scheme is ‘scientifically’ (or actuarially) funded, the fund will build up during the years when no major payouts are paid and then used when large payoffs are required to be paid.

4. Cashflow stability:- For new companies, the gratuity payments to employees would be few and low. However, gratuity payouts increase nearly exponentially as employees age and work longer. By having the liabilities funded, companies can replace the rapidly increasingly gratuity payouts with a relatively stable stream of contributions into the fund.

The establishment of Gratuity Trust requires in-depth knowledge of various rules/regulations and expertise. We have a team-leading Professionals, Litigation Partners, Chartered Accountants, Company Secretaries & Heads of Insurance Companies having decades of experience in providing their 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.
In case of any query or requirement of Accounting/Funding of Gratuity Benefit for your enterprise or for your client, you may contact us. We offer consultation for the following services:-
1. Consultation for Formation of a New Approved Irrevocable Gratuity Trust,
2. Consultation for Approval of Amendments in Gratuity Trust Rules, Deed or Merger/Demerger from Authority,
3. Consultation for Group Gratuity Schemes of LIC, SBI, HDFC and Bharati Axa,
4. Consultation for Support Services for Annual Accounting of Trusts,
5. Consultation for Investment Advisory for Privately Managed Gratuity Trusts,
6. Support Services for Actuarial Valuations in compliance of AS 15 (Revised 2005),
7. Support Services for Actuarial Valuations in compliance of IndAS 19,
8. Support Services for Actuarial Valuations in compliance of IAS 19 (Revised 2011)

Section 7 (3 A) of the Act of 1972 provides as under:-
“7(3 A) If the amount of gratuity payable under subsection (3) is not paid by the employer within the period specified in sub-section (3), the employer shall pay, from the date on which the gratuity becomes payable to the date on which it is paid, simple interest at such rate, not exceeding the rate notified by the Central Government from time to time for repayment of long-term deposits, as that Government may, be notification specify:
Provided that no such interest shall be payable if the delay in the payment is due to the fault of the employee and the employer has obtained permission in writing from the controlling authority for the delayed payment on this ground.”
16. Thus, the aforesaid provision makes the employer liable to pay amount of gratuity within 30 days from the date it becomes payable to the employee and once there is default in payment of gratuity within 30 days, the statutory liability of the employer comes in and employer is liable to make payment of interest on amount of gratuity not exceeding the rate notified by the Central Government from time to time by virtue of the provision contained in Section 7 (3 A) of the Act of 1972.

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