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GRATUITY TRUST SUMMARY

Group Gratuity Scheme : Under section 4A of the Payment of Gratuity Act,1972


gratuity amount is required to be insured by the employers. In this context Life
Insurance Corporation of India has floated a policy for insurance of gratuity to the
employees
of
organisation.
Under the above , a trust is required to be established by the employer for the
purposes of managing the gratuity funds. Trust will will create a fund with the LIC
against payment of gratuity. Contribution towards the fund are generally intimated
by LIC to trust on annual basis. This calculation is based on accturial basis. The
other part is insurance of the fund. Trust will deal with the LIC for payment of
contributions towards the gratuity fund and Insurance premium for the insurance
of
gratuity
to
the
employees
of
the
company.
These
premiums
are
to
be
paid
on
annual
basis.
Benefit of the same to the employer is that the contributions paid by employer to
gratuity trust will be recognised as expenses for the year in balance sheet though
these are to be utilised in future. Further in case a big number of employees
leave organisation at one time , the financial burden on the emloyer will not be
directly proportionate to the number of employees left. The reason is that the
employer has already discharged his liability in parts and has paid annual
premium.
The other biggest benefit is that in case of death of an employee during the
course of employment , the nominee will get gratuity amount not only for the
period of rendered services but till the date of retirement.This part is being taken
care by LIC against the insurance premium paid by employer.
It is suggested that before making trust rules ( Model copies are generally
provided by the LIC) please go through the same and amend as per your
requirement.
This trust is also required to be recognised by Income Tax Authorities. This part is
being taken care by LIC.
INCOME TAX RULES FOR GRATUITY
For Gratuity Payment Management, Employer has option to fund the liabilities
for payment of gratuity by setting up an irrevocable Trust and making
contributions to the Trust Fund. The Gratuity Trust Fund must be approved in
terms of Part C of the Fourth Schedule to the Income Tax Act, 1961. If a Trust
Fund is set up contributions can be allowed as deduction under section 36 (V) of

the
Income
Tax
Act,
1961
as
reproduced
below:
any sum paid by the assessee as an employer by way of contribution towards
an
approved fund created by him for the exclusive benefit of his employees under
an
irrevocable Trust. While payment of contribution is allowed as deductible
expenditure, gratuity payments will not be allowed as business expenditures
since
gratuity
will
be
paid
out
of
the
Trust
Fund.
2) The interest income of the Gratuity Fund is not liable to Income Tax in terms of
Section 10 (25) (iv) of the Income Tax Act, 1961 which deals with Income not
included in total income. 25 (iv) any income received by the Trustees on behalf
of
an
approved
Gratuity
Fund
3) Gratuity Trust Funds are also subject to Part XIV of the Income Tax Rules,
1962.
Income Tax Rules 98 to 111 deals with Approved Gratuity Funds. Most of the
Rules are procedure but more important Rules are reproduced below :

Rule
102
:
Admission
of
directors
to
a
fund
Where the employer is a company as defined in clause (i) of sub-section (1) of
section 3 of the Companies Act, 1956 (1 of 1956), a director of the company may
be admitted to the benefits of the fund only if he is a whole time bonafide
employee of the company and does not beneficially own shares in the company
carrying more than five per cent of the total voting power.
Rule
103
:
Ordinary
annual
contribution
The ordinary annual contribution by the employer to a fund shall be made on a
reasonable basis as may be approved by the Chief Commissioner or
Commissioner having regard to the length of service of each employee
concerned
so, however, that such contribution shall not exceed 8 1/3 percent of the salary of
each
employee
during
each
year.
Rule 104 : Initial contributions The amount to be allowed as a deduction on
account
of
an
initial
contribution
which an employer may make in respect of the past services of an employee

admitted to the benefits of a fund shall not exceed 8 1/3 percent of the
employees
salary for each year of his past service with the employer.
Initial contribution in respect of past services was expected to be paid in one
lump
sum but in terms of relocation, it can be paid in installments over a period not
exceeding five years. Annual contributions are restricted to 8 1/3 % of current
salary although gratuity is payable on final salary.

PART-11

Encyclopedia on Gratuity
1. Gratuity Meaning of

Gratuity refers to the gracious payments made to the employee in appreciation of


the prolonged services rendered by the employee to the employer and is normally
payable at the time of termination of employment or retirement or death of
employee.
2. Gratuity funds

Gratuity fund is generally established in the form of a trust. A few employees


become the trustees of such fund.
The contributions made towards the Gratuity fund generally depends on the
Actuarial Valuation. However, an employer may approach a life insurer in order to
purchase a group gratuity plan. The Gratuity trust can invest its funds by making a
contribution under a Group Gratuity Scheme of an insurer. Thus, the employer has
to pay annual contributions to the insurance company as decided by the insurance
company. The gratuity will be paid by the insurance company based upon the terms
of the group gratuity scheme.
3. Approved Gratuity Funds

Section 2(5) of the Act defines an approved gratuity fund as a gratuity fund which
has been and continues to be approved by the Chief Commissioner or
Commissioner in accordance with the rules contained in Part C of the Fourth
Schedule. In order to get the approval of the chief commissioner or commissioner,
an application needs to be made under Rule 109, including prescribed particulars
regarding the employer, nature of business of the employer, employees eligible to
participate in the fund and verified in the prescribed manner.
However, as per circular dated 3-11-1951 if the rules of a gratuity fund, duly
constituted under an irrevocable trust, satisfy certain prescribed conditions

(mentioned in table below), the contributions made by the employers may be


allowed as a deduction in their income-tax assessments and the rules need not be
forwarded for approval.

B
C
D
E

the benefit of the fund shall be open to only those persons who are whole-time
bona fide employees of the employer, having no substantial shareholding
interest;
the trust money shall be invested in such trusted securities as are payable
both as regards capital and interest in India;
the gratuity shall be made payable and shall be paid only in India;
the trustees shall be responsible for deduction of tax from the gratuities and
crediting the tax so deducted to the Government revenue;
the contributions shall be made on a reasonable basis acceptable to the
Income-tax Department, i.e., either on actuarial basis or any other basis
having regard to the length of service of each employee concerned;
so much of the contribution as cannot properly be treated as ordinary annual
contributions shall be treated by the Commissioner of Income-tax in the same
manner as is adopted by the Central Board of Revenue to deal with similar
contributions to an approved superannuation fund.

Rule 4(1) of Part C of the Fourth Schedule to the Income Tax Rules specifically lays
down that an application for approval of a gratuity fund shall be accompanied by
two copies of the accounts of the fund for the last three years for which such
accounts have been made up. This provision contemplates that an application for
approval may be made 3 years after the establishment of a gratuity fund. However
the board has clarified that, in order that the benefits of approval for the
intervening period may not be denied to bona fide gratuity funds, the
Commissioners may, after considering all the relevant facts of the case, accord
approval to a gratuity fund with effect from the date from which it satisfies the
conditions laid down in rule 3 of Part C of the Fourth Schedule. Hence if the fund
satisfies the conditions for approval laid down in Rule 3 than such a fund can make
an application for approval.
Rule 2(2) of Part C of the Fourth Schedule to the Income-tax Act, provides that the
Commissioner shall communicate to the trustees of a gratuity fund the grant of
approval with the date on which the approval is to take effect.
4. Appeal against the order of chief commissioner or commissioner

refusing approval

An employer, objecting to an order of the Chief Commissioner or Commissioner


refusing to accord approval to a gratuity fund or an order withdrawing such
approval may appeal, within sixty days of such order, to the Board in Form No. 44
verified in prescribed manner and accompanied with a fee of one hundred rupees.

5. Contributions to the Fund


a. Initial Contributions

When a new fund has been formed and approved, the employer may make
contribution to such fund in respect of the services rendered in the past years by
the existing employees. Such contribution however shall not exceed 8 1/3 per cent of
the employees salary for each year of his past service with the employer.
b. Annual contributions

The ordinary annual contribution by the employer to a fund shall be made on a


reasonable basis as may be approved by the Chief Commissioner or Commissioner
having regard to the length of service of each employee concerned so, however,
that such contribution shall not exceed 8 1/3 per cent of the salary of each employee
during each year.
6. Contributions by employer, when deemed to be income of employer.
Where any contributions by an employer (including the interest thereon, if any) are
repaid to the employer, the amount so repaid shall be deemed for the purposes of
income-tax to be the income of the employer of the previous year in which they are
so repaid.
7.Winding up or amalgamation of the fund
Winding up or amalgamation of the fund with another fund shall require the prior
approval of the Chief Commissioner or commissioner.
8.Winding up of business of employer
At the time of winding up of the business of the employer, the employer shall make
satisfactory arrangements for payment of benefits to existing beneficiaries of the
fund.
9. Variation to the rules of the fund

Rule 110 of the Income tax rules lays down that any amendment to the rules of the
fund requires the prior approval of the Chief commissioner or commissioner.
10. Deduction of contribution made to approved gratuity funds

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.
However, no allowance shall be made in respect of a payment to a provident or
other fund established for the benefit of employees unless the employer has made
effective arrangements to secure that tax shall be deducted at source from any
payment made from the fund which are taxable under the head Salaries.

11. Deduction of contribution made to other than approved gratuity funds


Section 40(A)(7) places a bar on deduction of any provision made for payment of
gratuity by the employer except where the same is for contribution to approved
gratuity fund or if the gratuity is payable in the previous year in which such
provision is made.
12. Income of an approved Gratuity Fund

Income of an approved gratuity fund is exempt under Section 10(25)(iv).


13. Taxability of gratuity in the hands of employees

Gratuity payable to an employee is taxed as part of the employees 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. 3, 50,000 (in both cases) under Section 10(10).