Formation of gratuity trust

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Tikaram Chaudhary

Founder of Gratuity Trust Fund Consultan

2325 Points Joined May 2015

The Payment of Gratuity (Amendment) Act 2018 provides Social Security to Employees working in all organizations such as a factory, mine, oilfield, port, railways, plantation, shops, establishments or Educational institution (i.e. Schools) having 10 or more employees on any day in the preceding 12.

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.

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

In the case of (c) vesting condition of 5 years does not apply.

Gratuity Benefits depends upon last drawn monthly wages and is linked to the length of service, normally it goes on increasing from the time when the employee joins service and the time of his exit from service due to following factors:-

(a) Annual Increase in Past Service of Employee.

(b) Annual Increase in wages of Employee.

(d) Increase in Ceiling Limit on Gratuity Benefits due to the amendment in The Act,

(e) The decrease in waiting Condition of 5yrs. due to the amendment in The Act.

(For detailed information for the impact of the above change in Gratuity Visit my blog: https://gratuityconsultant.blogspot.com/2019/03/a-note-on-factors-increasing-gratuity.H T M L)

Due to changes in the above factors/amendment in the Act, the gratuity payments to the Employees at the time of their exit from the organization in event of retirement, resignation, disablement/ death, increase drastically and it consumes large chunk of organization profits, so it becomes mandatory for organizations to get the Actuarial Valuation Report/Certificate from An Actuary under Gratuity Plan to comply with the requirement for Accounting of Gratuity Benefits in compliance of AS 15 (Revised 2005) and IndAS 19.

Provision of Gratuity Liability in Financial Statements/Balance Sheet is not allowed as a deduction until and unless organization forms an approved Gratuity Trust as per rules of Income Tax rules, 1962 and make initial and yearly contributions into the Gratuity Trust. The initial and annual contributions made by the organization in an approved gratuity trust are treated as a deduction. Also, Income from the Gratuity Trust Investment is exempted for Income Tax.

Formation of Gratuity Trust and Assistance in preparation of Inputs for Actuarial Valuation of Gratuity requires technical and in-depth knowledge of rules/regulations, amendments of the Payment of Gratuity (Amendment) Act 2018, Accounting Standard/Accounting Standards and hence Consultation of Professionals dealing with this subject becomes mandatory for HR/Accounts/Financial Planning Departments of the organization including Schools.

Replies (2)

Tikaram Chaudhary

Founder of Gratuity Trust Fund Consultan

2325 Points Joined May 2015

Factors Affecting the Increase in the Gratuity & Benefits of Setting up Gratuity Trust Fund

An Overview Gratuity Benefits

Gratuity benefits are governed by "The Payment of Gratuity Act 1972" and paid by the Company to an employee in addition to his salary on exit from the company. Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years, -

(a) on his superannuation, or

(b) on his retirement or resignation, or

Provided that the completion of continuous service of 5 years shall not be necessary where the termination of the employment of any employee is due to death or disablement:

Calculation of Gratuity Benefits

Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal benefit. It means, Gratuity amount will be determined when monthly terminal wages of the employee are known to the company. The terminal wages will include Basic & Dearness allowance only. The Gratuity Benefits are calculated using the following formulae:-

(15/26) multiplied by (No of Completed Years on Exit) multiplied by (Terminal Wages)

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,

(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,

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 Formulae 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 changes 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 Gratuity Ceiling 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 Gratuity Ceiling 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 Gratuity Ceiling 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.

Gratuity Benefits are long term benefits and are subject to the above changes, so it becomes mandatory for Companies to make Accounting/Investment for Gratuity Benefits.

Companies generally opt "Pay as you go option" for Accounting of Gratuity Benefits in their Financial Statement. In this option, Company makes a provision of Gratuity in the Balance Sheet on the accrual basis taking an actuarial report on BS date from an Actuary and as and when an employee leaves the organization, the company pay gratuity from their resources and get the tax benefit for the gratuity paid.

In the case of Established Indian Companies, they set up a Gratuity Trust and make an annual contribution equivalent to their Accounting Provisions of Gratuity in the "Irrevocable Trust" and avail the tax benefits under Section 36(1)(v) of the IT Act 1961 and create a Corpus in "Irrevocable Trust" which is used exclusively to meet with Companies obligation towards Gratuity Payments as and when the employee resigns or retires from the companies.

We have a Team of Litigation Partners, Labor Law Experts, Finance/Insurance Professionals for handling Accounting/Investment for Gratuity Benefits and we have provided consultancy for administration Gratuity Trust Fund/Retirement Trust Fund in various organization in all sectors of Indian Economy on receipt of their Management request and If you wish to know details like:-

1. Who can be covered under Group Gratuity Scheme?

2. Why companies required to create a Group Gratuity Trust - Decision Making?

3. How can companies administer Gratuity Trust?

4. What are Tax Benefits to Company by setting up Gratuity Trust?

5. What are General Benefits to Employee from a Gratuity Trust Set up by Company?

6. Where to approach for setting up Gratuity Trust?

7. What is the documentation required for setting up Gratuity Trust?

8. What is the Process of Setting up a Gratuity Trust?

9. Which is beneficial to trustees a Self Managed Investment or Insurance Co. Managed Investment?

10. What is the Accounting requirement for Trustees?

We may also be contacted for other alternate ways the company can choose for the administration of Investment for Retirement Benefits and Long Term Retention Schemes f Productive Employees/Top Management of Companies?

Tika Ram Chaudhary

Head Consultant

Gratuity Fund Trust Consultant

Mobile Number : 9211637063

Email ID : tikaramchaudhary @ gmail.com, gratuityconsultant @ gmail.com

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Blog : https://gratuityconsultant.blogspot.com ,https://gratuitytrustfundconsultantindelhincr.blogspot.com,

Website : https://gratuity-trust-fund-consultant-in-delhi-ncr.business.site/?m=true

(All Consultancy Services provided by us are subject to terms & conditions will be stated when a consultation job is accepted.)

Tikaram Chaudhary

Founder of Gratuity Trust Fund Consultan

2325 Points Joined May 2015

In Indian context most reputed Indian and Multinational Companies can Save Tax up-to 32.50% by Forming a CIT Approved Gratuity Fund under Irrevocable Trust and Investing the Initial and Annual Contribution equivalent to provision of Gratuity Liability in Balance Sheet annually (Refer Section 36 (i) (v) and 10 (25) (iv)) and Section 10 (25)(iv), which is disallowed under Section 40 (a) (7) of the Income Tax Act, 1961.

The below example may help you the understanding “What benefits are companies are not getting if they don’t create CIT Approved Gratuity Trust”:-

Scenario 1. If company does not have a CIT Approved Gratuity Fund under Irrevocable Trust

then

If the Actuarial Valuation Liability of Company under Gratuity Plan is INR 10 Crore since company has not created any CIT Approved Gratuity fund under Irrevocable Trust then total provision of INR 10 Crore Gratuity Liability will be disallowed whilst Computing Net Income for Income Tax Computation of Company.

Scenario 2. If company has created a CIT Approved Gratuity Fund under Irrevocable Trust

then

If company had Formed An Approved Gratuity Fund (i.e. As per Clause 5 of Section 2 of Income Tax Act 1961) under Irrevocable Trust (i.e. As per provisions of Clause (a) of Sub-Section 2 of Section 3 of Part C of Fourth Schedule the Income Tax Act, 1961) then company will Transfer INR 10 Crores Bank Account of CIT Approved Gratuity Trust and INR 10 Crore will be allowed as expense under Section 36 (1)(v) of The Income Tax Act 1961 and Interest Accrued on this 10 Crore Amount is also Tax Exempted under Section 10 (25) (iv) of The Income Tax Act 1961. (CIT Approval in terms of Rule 4 of Part C of of Fourth Schedule the Income Tax Act, 1961 is must requirement for taking this Tax Benefit)

For getting the above taxation benefits companies Form CIT Approved Gratuity Fund under Irrevocable Gratuity Trust as per provisions of following Rules/Regulations and Acts :

1. Rule 98 to 111 of the IT Rules, 1962
2. Part C of Fourth Schedule of IT Act, 1961,
3. Indian Trust Act, 1882,
4. The Payment of Gratuity Act, 1972 (a)
5. The Payment of Gratuity Rules 1972
6. The Karnataka Compulsory Gratuity Insurance Rule, 2024
7. Telangana Compulsory Gratuity Insurance Rules 2016
8. Andhra Pradesh Compulsory Gratuity Insurance Rules, 2011
9. Accounting Standards 15 (Rev 2005) & IndAS19
10. APS 27 of the Institute of Actuaries of India

(Kindly refer to the relevant para's and Section of the above mentioned Act/Rules for understanding the process of Formation of approved Gratuity Fund under Irrevocable Trust.