Impact of closure of investment in gratuity fund

Hi Nitesh,

Thanks for your question on the closure of an LIC policy linked to a gratuity fund. Here’s a detailed analysis of the tax and accounting implications:

1. Impact on Benefits of LIC / Loss to the Company

• The LIC policy is typically a gratuity fund investment, where premiums are paid regularly and the fund accumulates to pay gratuity liabilities.

• If the policy is closed prematurely:

  • Surrender value will be received from LIC, which may be less than the total premiums paid plus accrued benefits, depending on the policy terms and duration.

  • There could be loss of future interest and risk cover benefits (like insurance cover linked with the policy).

  • The company may lose the assured return or guaranteed benefits if any.

• Financial loss depends on the surrender value vs premiums paid.

2. Impact on Trust Account

• The gratuity fund is managed through a separate trust account.

• On closure:

  • The trust will receive the surrender proceeds from LIC.

  • The trust needs to properly account for this amount and use it to discharge gratuity liabilities.

  • Any shortfall or surplus in the trust account (compared to actuarial liability) should be adjusted accordingly.

• The trust continues to exist until all gratuity liabilities are settled.

3. Impact on Income Tax

• For the Company:

  • Premiums paid to LIC as part of gratuity fund are allowed as business expense under section 37.

  • On closure, the surrender value received is taxable as income to the company under “Income from other sources” (if the company is the owner of the policy).

  • However, if the trust is the owner of the policy, the surrender proceeds accrue to the trust and not the company directly.

• For the Gratuity Trust:

  • The trust is exempt under section 10(23FB) if it fulfills conditions under section 17(2) of the Gratuity Act.

  • The surrender proceeds received by the trust are not taxable if used for discharge of gratuity liabilities.

  • If the surrender value exceeds the liability, the excess may be taxable unless properly accounted.

• Employee Tax Impact:

  • Gratuity paid to employees as per the Payment of Gratuity Act is exempt under section 10(10).

• Other Considerations:

  • If the gratuity fund is recognized and following provisions of the Income Tax Act, any surplus or deficit in fund needs actuarial valuation and adjustment.

Summary Table

Recommendations:

• Consult with LIC to understand exact surrender value and terms.

• Review actuarial valuation to assess gratuity liabilities vs fund balance.

• Maintain proper documentation and accounting for surrender proceeds.

• Consult your tax advisor before closure to optimize tax impact and compliance.