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This email is prepared to create awareness about Taxation Benefits available under Accounting & Funding arrangement for discharging the obligation under Gratuity Benefit (i.e. Defined Benefit Plan) to Companies, NBFC's, Financial Institutions, MNC's, Schools and other business entities having more than 10 employees among-st CA / CS / AUDITORS & Company Personnel involved in Finalization of Financial Statements such Balance Sheet .

1. Brief about Gratuity Benefit



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

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.

5. 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,



6. 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 Formula 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 change 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 Ceiling Limit on Gratuity Payment 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 Ceiling Limit on Gratuity Payment 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 Ceiling Limit on Gratuity Payment 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.



7. 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:-

1. 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).

2. 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).

3. 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).

4. 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). Applicability of compulsory insurance for Gratuity may be notified by the other State Governments because compulsory insurance of gratuity secures the gratuity benefits of employee even in case of bankruptcy of the company.

8. Options available to Companies for Discharging the Gratuity Liability

From point No. 5, 6 & 7, we conclude that the Gratuity Liability of companies increase exponentially with the increase in wages of employee, service period of employee, regulatory changes as shown in point 6 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 7 (2) above. Employers generally have 2 options for discharging the Gratuity Liability: –

1. Accounting Option also called Pay as go Option – It is a mandatory in nature

2. Funding Option– It is mandatory in Andhra Pradesh/Telangana and optional in other states of India

8(a). Accounting Options

Accounting Option – Under this option provision of gratuity is made in Financial Statement of the Company by taking Actuarial Valuation Report from the Actuary and when employee leaves the company employee, employer pays the gratuity from their own resources. This option is called "Pay as you go Option". This is mandatory for all companies having 10 or more companies. Few more points to be considered by the Auditors whilst Auditing the Financial Statement in respect of Accounting of Gratuity Benefits are as under :-

A. Every registered company needs to prepare the Financial Statements such as Balance Sheet & Profit/Loss at the end of Accounting Year to comply with requirement of Section 133 of Companies Act 2013.

B. Accounting of Gratuity Benefits is prescribed in Accounting Standard 15 (Revised 2005) and it is mandatory in nature. Accordingly companies made provision of Gratuity Liability in their Balance Sheet to Comply with the requirements of following Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI) by taking an Actuarial Valuation Report/Certificate from Actuary (Refer Para 49 of AS 15 (Revised 2005))



C. Ministry of Corporate Affairs notified Financial Reporting Authority (NFRA) rules 2018 on 13.11.2018. The main Functions and duties of the NFRA Authority are Recommending accounting standards and auditing standards, Monitoring and enforcing compliance with Accounting Standards and Auditing standards, Overseeing the quality of Audit service and suggesting measures for improvement, Power to investigate, Disciplinary proceedings, Manner of enforcement of orders passed in disciplinary proceedings, Punishment in case of non-compliance etc.

In Indian context, Companies needs Actuarial Services for Compliance of following Accounting Standards for Accounting of Defined Benefit Plans (i.e. Gratuity Plan, Leave Encashment Plan, Pension Plan, PRMB etc.):-

I. AS 15 (Revised 2005)

II. IndAS 19

II. IAS 19 (Revised 2011) – IFRS

The following criteria are followed by the companies for compliance of above Accounting Standards and for Accounting of Defined Benefit Plans is as under:-

(i) SME Companies - These companies need to disclose details as required for Clause (l) of Para 120 of AS 15 (Revised 2005) - (Refer notification dated 7th December, 2006 of Ministry of Company Affairs for Accounting Standards)

(ii) Non - SME Companies - These companies needs to disclose details as required for Para 120 of AS 15 (Revised 2005)

(iii) Companies with Net-worth more 250 cr. - These companies and their subsidiaries has to give disclosure of in compliance of IndAS 19 with comparative numbers of previous 2 years.

(iv) Multinational Companies - These companies needs to comply with IAS 19 (Revised 2011)-IFRS for provisioning of Defined Benefit Plans in their Financial Statement for consolidated provisioning in Financial Statement of their International Group Companies.

8(b). Funding Option

Funding Option –In this option, Companies make provision of Gratuity liability in the balance on annually on accrual basis based on actuarial report but it is not allowed as deduction whilst computing net Income of Income Tax (Refer Section 47A (7) of Income Tax Act 1961), So companies prefer to create Gratuity Trust. There are 2 major benefits to the company by creating an Irrevocable Trust:-

(i) Contribution into Approved Trust is allowed as deductible Expense - Provision of Gratuity Liability shown in the Balance Sheet is not allowed as deduction whilst computing net Income for Income Tax ((Refer Section 47A (7) of Income Tax Act 1961) whereas Initial and Annual Ordinary Contribution made by company into an Approved Gratuity Trust (Subject to condition specified in Income Tax Rules 103 & 104) is allowed as deductible expense under Section 36 (1) (v).

(ii) Interest received from Investment of an Approved Gratuity Trust is also exempted as Income Tax :- Interest received from Investment of an Approved Trust is also exempted as Income under Section 10 (25) (iv) of the Income Tax Act, 1961.



8(c). Examples for understanding Taxation Benefits under Accounting and Funding Option



Taxation of Gratuity Payment under Pay as go options :-

To understand this, let us take an Example,

Mr. A Joins the Organization with a Basic Pay of Rs. 26,000/- per month and monthly CTC of 50,000/-. Assuming that expected increase in basic salary is assumed to be 10% p.a.

Gratuity Payments for next 5 years will be :-

On Completion of 1 Yr – (15/26)* 28,600*1 = 16,500/-

On Completion of 2 Yrs – (15/26)*31,460*2 = 36,300/-

On Completion of 3 Yrs – (15/26)*34,606*3 = 59,895/-

On Completion of 4 Yrs – (15/26)*38,067*4 = 87,847/-

On Completion of 5 Yrs – (15/26)*41,873*5 = 1,20,788/-

Now, Expected Tax Benefit calculation in case of “Pay as you Go Option” is as under :-

For Provision of 1st Yr – NIL

For Provision of 2nd Yr – NIL

For Provision of 3rd Yr – NIL

For Provision of 4th Yr – NIL

For Payment on 5th Yr – 1,20,788/- In this case company,

Mr. A will leave the company then company will get the tax benefit of Rs. 1,20,788/-.

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 contributes the annual contribution in this Gratuity Trust and gets the Tax Benefits. In this case, when Mr. A will leave the company, gratuity will be to Mr. A from the Gratuity Trust.

Expected Tax Benefit calculation in case of “Funding Option” under Section 36(1)(v) of the IT Act 1961 for Annual Contribution which is 8.33% of Annual Basic Salary of Employee.



For Contribution of 1st Yr – 28,600*12*0.833 = 28,589/-

For Contribution of 2nd Yr – 31,460*12*0.833 = 31,447/-

For Contribution of 3rd Yr – 34,606*12*0.833 = 34,592/-

For Contribution of 4th Yr – 38,067*12*0.833 = 38,051/-

For Contribution of 5th Yr – 38,067*12*0.833 = 41,857/-

In this case, Mr. A will get gratuity of Rs. 1,20,788/- from the Gratuity Trust and employer will get approximate Tax Benefits of Rs.1,74,536/- for annual contribution made by him in previous 5 years.

For more details in the matter you may visit my published article on www.taxguru.in at following weblink :- https://taxguru.in/income-tax/factor...-benefits.html

The establishment of Gratuity Trust & compliance of Accounting of Employee Benefits Valuations requires in-depth knowledge of various rules/regulations and expertise. We have a Team of Leading Professionals, Litigation Partners, Chartered Accountants, Company Secretaries & Heads of Insurance Companies having decades of experience in providing 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. We have more than 10 years of experience in providing Consultancy and Support Service in following matters:-



Consultancy Services for Formation of Gratuity Trust for Gratuity Benefits



1. Formation of a New Approved Irrevocable Gratuity Trust.

2. Investment of Trust Money as per Income Tax Rules 1962.

3. Gratuity Trust Deed, Trust Rules, Applications.

4. Approvals of Trust in terms of Part C of Schedule IV from Income Tax Department in following cases :-

o Approvals for New Gratuity Trust or Group Gratuity Scheme

o Approvals for Change in Trust Deed

o Approvals for Change in Trust Rules

o Approvals for Change in Object of Trust

o Approvals for Change in Trustees

o Approvals for winding up of Trust due to winding up of the Company

o Approvals for amalgamation with another fund due to merger/acquisition of the Companies

5. Investment of Trust Money in Group Gratuity Schemes of Insurers.

• Traditional Group Gratuity Schemes of LIC

• Unit Linked Gratuity Schemes of Insurance Companies



Services Offered by our Professional Associates for Accounting of Gratuity Benefits



6. Actuarial Valuations in compliance of following Accounting Standards:-

o AS 15 (Revised 2005)

o IndAS19

o IAS 19 (Revised 2011)

o USGAAP



The services offered by us may be needed by you or by your client:-



I. For compliance of Accounting Standards whilst preparing the Balance Sheet and Profit/Loss Statement as stipulated in Section 133 of the Companies Act 2013, so that they can give a true and fair view of state of affairs of the Company.

II. For getting the Tax Benefits under Section 36 (1) (v) & Section 10 (25) (iv) of the Income Tax Act, 1961 by creating an Approved Gratuity Trust or by starting an Group Gratuity Scheme of Insurer before closure of Financial Year ending 31.03.2020.



Since annual financial statements such as Balance Sheet and Profit/ Loss Statement of your clients are at hand for the close of the financial year as on 31.03.2020, the services we deal in will be needed by many of your clients and we will be happy to provide our services if needed. In case of any clarification, you may contact me at 9211637063 or email me your queries at .

Regards



Tika Ram Chaudhary

Gratuity & Leave Encashment Trust Fund Consultant

(Corporate Consultant with more than 10 Years of experience in providing Support Services for Actuarial Valuations in compliance of AS 15 R, IndAS 19 & IAS 19 R under Gratuity and Leave Encashment and Formation of Gratuity and Leave Encashment Trusts)

Registered Office Address: R 11, First Floor, R Block, Vikas Nagar, Uttam Nagar, New Delhi -110059

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