Gratuity Trust Compliance requirements under Income tax Act



Employers contribution to an approved gratuity fund is allowable as a deduction under Section 36(1)(v) while computing business Income

The following points may be noted in respect of such Gratuity Fund

  • 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 to Trust and Trust will pay to respective employee. 
  • 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.  
  • If your gratuity fund registered u/s under rule 2 (1) part 'c' of part 'C' Schedule of It act than ---- Income of an approved gratuity fund is exempt under Section 10(25)(iv).
  • Further it should maintain books of account and audited annually,return of gratuity fund will be filled in ITR -7.   



Creation of Gratuity Trust by company vide a trust deed







Amendments to Trust deed based on observations of Income tax Department






Gratuity Trust Rules & Regulations













Taxation of Gratuity Trust




Status of Approved Gratuity Fund
A Separate PAN number is required to file income tax return of approved gratuity fund. In the application, it has to be mentioned as trust which amounts to body of individuals under Income Tax Act.
To conclude in eyes of Income Tax, approved gratuity fund is Body of Individuals.
What will be the treatment of Income Earned under Income Tax Act 1961?
Section 10(25) (iv) of Income Tax Act says any income received on behalf of the approved gratuity fund is exempt from tax. But again there is some confusion whether income received by trustee is only exempt? Or income such as interest accrued on gratuity funds is also exempt?
In our opinion, any income earned by approved gratuity fund is exempt under Income Tax Act, as the gratuity fund is represented by trustees. The same thing is there in definition of representational assesse. Below is the extract of the definition of representational assesse
For the purposes of this Act, “representative assessee” means in respect of income which a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise [including any wakf deed which is valid under the Mussalman Wakf Validating Act, 1913 (6 of 1913),] receives or is entitled to receive on behalf or for the benefit of any person, such trustee or trustees
Point to be noted: Every representative assessee shall be deemed to be an assessee for the purposes of this Act
To conclude: Whether income is accrued in gratuity fund or received by trustee, such income is exempt from tax
How to File the Income Tax Return of Approved Gratuity Fund?

Even though income is exempt from tax, the details of such income have to be shown in relevant ITR and then exemption under section 10 should be claimed. 



Group Gratuity Scheme from Insurance company 

Life Insurance Corporation of India offers its Group Gratuity Cash Accumulation scheme to enable employers to meet their gratuity liability in a very simple and efficient manner. The scheme is formulated in compliance with Part C of the IV schedule of Income Tax Act and tax benefits are available as provided in Income Tax rules
The gratuity arrangement with LIC provides the following services to the company
  • Fund management under interest accumulation system
  • Claim settlement on exit as per company rules/gratuity act
  • Built in Insurance arrangement for the employees for future service
  • MIS related to Income Tax and trusts accounts and Actuarial valuation
Fund management: Critical issues
Safety:           
Liability on account of gratuity experiences sharp increase every year due to its nature of its computation.  Apart from increase in service, increase in salary also contributes to increase in liability substantially as the benefits are payable on last drawn salary.  Hence funds have to be invested in a conservative way with a consistent growth and insulated from market risks
The unique advantage with LIC is the contributions made by the company and interests credited by LIC are irreversible. This ensures highest level of safety for the total corpus and consistency in future contributions. As the gratuity payments are statutory and LIC gratuity scheme being the only investment tool which enjoys sovereign guarantee, gives a greater comfort to employer.
Liquidity: Funds available with LIC is a single account for investment and claim settlement. Hence 100% liquidity is ensured for the purpose of claim settlement
Yield: LIC has been offering very competitive and consistent interest rates over the years. For the year 2009-10, LIC has offered 9.00% - 9.65% depending on fund size. The interest declared is net of administrative expenses incurred, hence no separate charges are charged after crediting the interest.
Interest rate offered by LIC is on daily balancing method. Hence, there is no idle time for earning interest, hence effective rate of interest is much higher. Another significant aspect is interest gets compounded annually, hence no reinvestment issues and no time lags.
No responsibility on trustees on Investment decisions: Trustees are free from all investment risks and hassles in cash accumulation system. Advantage of ‘real outsourcing’ can be derived by associating with LIC
No hidden charges: The scheme is focused on a long term association in compliance with investment regulations and statutory payment obligations and no charges are levied on the transactions for which the fund is meant for.
Funding can also be in a staggered pattern during the year, but no charges at entry level for any number of payments. No charges on withdrawals for resignation or retirement or death. Total corpus comprising of money contributed by the company and interest credited by LIC is available for claim settlement up to 100% subject to availability of funds.
Actuarial recommendations: On annual basis, LIC provides this information to the trustees and recommends the level of contributions.
Claim settlement: On the exit of an employee due to retirement / death/ resignation, trust may prefer a claim from LIC by sending a claim form.  Claim amount will be made available to trustees. Trustees can have the following options
  • Preferring a claim from LIC and paying to employee
  • Paying the money to employees and seek reimbursement
  • Paying claims to employees at their end and seeking annual reimbursement
MIS: LIC provides statement of receipts and payments and actuarial valuation certificate and certificate of balance for the trust account.
Besides the above said advantages, the scheme also provides for employee welfare measures with built in insurance cover.
  • Insurance cover for future service gratuity
 Another salient feature of the Gratuity Scheme with LIC is that it provides for insurance coverage to the employees to the tune of future service gratuity subject to certain limits.  The insurance cover can be flexible depending on the requirements of the Trust. The Group Insurance premium will be commensurate to the cover provided.
  • Income Tax Benefit on Insurance Premium
The insurance premium paid towards the above said benefits is treated as deductible business expenses to the company.The premium is not treated as perks in the hands of the employees




ICICI Prudential Group Gratuity Plan

ICICI Prudential Life Insurance offers a unit-linke d group gratuity plan that helps you to fund the statutory gratuity obligation in a scientific  manner and also avail of the tax benefits as applicable to approved gratuity funds. 

Eligibility

Our Group Gratuity Plan covers
             Employer- employee groups.  
       group size of 25 and above


What is the gratuity benefit payable?

The employer can provide gratuity benefits as per the rules of the schemes framed with reference to the Gratuity Act or on better terms as decided by the company. The benefit payable will be the accrued gratuity amount for the employee and the bundled life cover (in case of death)

Bundled life cover
Our plan provides greater value to your employees by packaging gratuity with life insurance. This cover can be extended in any of the following ways:

       as a flat/graded cover which can be a minimum of Rs. 1000 per employee, or,
       on the basis of Anticipated Gratuity which is the amount paid over and above the Accrued Gratuity of an employee in the event of his premature death before retirement age, for the balance years of his service.
The premiums for the bundled life cover are payable annually in advance. The same is stated explicitly over and above the gratuity contributions payable.

  
How would contributions be made?

The contributions made towards the Gratuity liability will depend on the Actuarial Valuation

You can estimate your gratuity liability based on an actuarial valuation provided by a qualified actuary by way of an AS-15 Certification.

For a newly set up gratuity trust, the Past Service Gratuity Liability payment can be made over a period of five years. The annual contributions can be made in annually/ quarterly/monthly installments.

Product Offering

ICICI Prudential offers a market linked plan that offers higher flexibility and transparency than any other traditional or self-administered fund. We offer multiple fund options under the Group Gratuity Plan to meet your diverse financial goals. The investments will be made in accordance with the fund objectives.

Fund Option
Asset Allocation
Objective
Group     Short      Term
Debt Fund
100%: Debt securities,
Money market Instruments
& Cash (including Debt
Schemes  of Mutual Fund) 
To provide suitable returns through low risk investments in debt and money market instruments with an underlying objective to attempt to protect the   capital deployed in the fund.
Group Debt Fund
100%: Debt securities,
Money market Instruments
& Cash (including Debt
Schemes  of Mutual Fund) 
To provide accumulation of income through investment in various fixed income securities. The Plan seeks to provide capital appreciation while maintaining suitable balance between return, safety and liquidity.
Group Balanced Fund 
Minimum 80%: For Debt securities, Money market Instruments & Cash  (including Debt Schemes of Mutual Fund)

Maximum 20%: For Equity
and equity related
securities
Balanced                Plan        is                 aimed     at
generating a healthy mix of longterm capital appreciation along with current income. The strategy is to invest in equity as well as fixed income instruments in optimum proportions as derived from the analysis of prevalent market conditions from time to time.
Group Growth Fund
Maximum 60%: For Equity
& Equity related securities 

Minimum 40%: For Debt securities, Money market Instruments & Cash (including Debt Schemes  of Mutual Fund)
To primarily generate long-term capital appreciation through investment in equity and equity related securities and complement it with current income through investment in fixed income instruments in appropriate proportions depending on market conditions prevalent from time to time.
Benefits of our Market Linked Plan

Flexibility

Multiple Investment Options – Choice of multiple funds with a flexible investment pattern

Switching Option - While you have chosen a fund option, you have the flexibility of switching between our various funds at any time. Switching between the various funds is allowed depending upon your requirements. We allow unlimited switches free of cost every year.

Contribution Redirection – The contributions can be redirected for investments into a fund of your choice and need not adhere to the initial investment pattern.

Transparency 

Portfolio Disclosure – Quarterly disclosure of the funds, enables you to achieve better fund management.  

NAV* declaration- NAVs declared daily, enabling you to track the performance of the fund chosen by you. 

*NAV =(Market / Fair value of scheme’s investments+ Current Assets – Current Liabilities & Provisions)                                      No. Of units Outstanding under the relevant plan

Unit Pricing- The contribution received in respect of the client is converted into number of units based on the Net Asset Value (NAV) per unit at that point of time.


Explicit charge structure – The charges for our Group Gratuity plan are categorized into the following 

ƒ  Annual Recurring Charges - ICICI Prudential Life Insurance shall charge fund management fee for assets under fund management. This fee will be based on the size of the fund and type of investment option chosen.

ƒ  Exit Load – In the event a company wants to surrender / exit their gratuity fund with ICICI Prudential; an exit charge would apply based on the year of exit. These charges will not be applicable if he Policy is in existence for more than 3 years.  
Services

       Dedicated account manager
       Settle Claims and payouts within specified turn around times
       Assistance in setting up of a new trust and transfer of existing schemes.
       Legal & Taxation helpdesk for your gratuity fund
       Financial planning for your employees

What happens when employees join or leave the scheme?
       All new joinees become a part of the group, if they meet the eligibility criteria. The life cover starts from the date of joining the company.


       The particulars of the new joinees may be submitted by the Employer on a monthly basis. The term premiums are payable annually in advance (on a pro-rata basis) and the annual contribution can be paid in the specified installments.
       In case of an individual leaving service or the group, life cover will cease immediately. The proportionate premium will be refunded for the employees leaving the scheme. The gratuity accrued will be paid to the employee if eligible.
       For all death claims the life cover along with the accrued gratuity will be payable to the beneficiary.
Taxation Implications*

¾  Under Payment of Gratuity Act, 1972, on completion of 5 years of service, for every completed year of service or part thereof in excess of 6 months, the employer shall normally pay gratuity to an employee at the rate of15 days’ wages based on the rate of wages last drawn by the employee concerned.

¾  Employer may make an Initial Contribution in respect of past service

¾  Past service liability if funded by payment of single or in installments not exceeding FIVE, then the whole of contribution will be eligible for tax relief in the year of payment

¾  Contribution paid to the trust fund by an employer is treated as an business expenses. (Sec 36 (1)(v))

¾  Amount allowed as deduction shall not exceed 8.33% of the salary (Generally Basic Plus D.A.).
  
¾  Under Sec 40 A (7) no deduction shall be allowed in respect of any provision made by the employer for the payment of gratuity to his employees on retirement or termination of their employment. Deduction in computing the income of the assessee for any assessment year is available only on actual contribution of the liability to an approved gratuity fund

¾  For the Gratuity fund to be approved by the Income Tax Commissioner it is necessary to set up an irrevocable Trust

¾  The Gratuity trust can invest its funds by making a contribution under a Group Gratuity Scheme of an insurer.

¾  The income of an approved gratuity fund is exempt under Section 10(25) (iv) 

¾  Gratuity payable to an employee is taxed as part of the employee’s salary income under Section 17 (i) (iii). However, Gratuity is tax free up to half months (15/26) average salary (of last 10 months) for each year of service, subject to a maximum of  Rs. 3, 50,000 under Section 10(10)

¾  All claims paid out from bundled  life  cover are eligible for tax deductions under Section 10(10)D



The contribution to gratuity fund is normally based on actuarial valuation report 
Actuarial Valuation Report for AS 15 - Accounting for Retirement Benefits




Gratuity Ceiling upto which it is a statutory right under the Act



Rule 101 of the Income-tax Rules,1962

Monies contributed to approved gratuity funds are required to be deposited in a Post Office Savings Bank Account or a current account with any scheduled bank, or are required to be utilised for the purpose of making contributions under Group Gratuity Scheme entered into with the Life Insurance Corporation of India. To the extent such monies are not so deposited or utilised, they are required to be invested in the modes of investment specified in rule 67(2) of the Income-tax Rules, 1962.


INVESTMENT PATTERN ALLOWED under Rule 67 
AMENDMENT IN RULE 67 NOTIFICATION NO. 24/2009, DATED 12-3-2009

The tax-free status would allow more of retirement savings to flow into shares The Central Board of Direct Taxes (CBDT), the apex direct taxes body has now issued a notification, aligning the investment pattern prescribed in its rules with the new one given out by the Department of Economic Affairs, to allow these funds’ equity investments tax-free status. The DEA, under the finance ministry had announced the new investment formula for these funds in August, 2008, permitting them to invest up to 15% of their corpus in the stock market instead of the earlier 5%. The new investment pattern comes into effect from April 1, 2009. Therefore, aligning the CBDT investment pattern with the one prescribed by DEA was very crucial for these entities to retain their tax-free status.
Income-tax rule 67 prescribes an investment pattern for private provident funds and superannuation funds which is to be followed mandatorily to avail tax benefits. Income earned on investments not in line with the pattern prescribed by tax body face tax.
As per the new patter, equity investments can made in shares of companies on which derivatives are available in BSE/NSE.
The funds would also be able to channelise up to 55% of their funds in central and state government securities and units of mutual funds investing in such securities. The new pattern also allows these entities to park their funds to the tune of 40% in debt securities with maturity of not less than three years tenure issued by companies, banks and public financial institutions, term deposits of scheduled commercial banks and rupee bonds having an outstanding maturity of at least three years issued by multilateral institutions such as the International Bank for Reconstruction and Development, International Finance Corporation and the Asian Development Bank. Investments in money market mutual funds has been capped at 5% of the total corpus






APPROVED GRATUITY FUNDS - Income-tax Rules, 1962
APPROVED GRATUITY FUNDS
Rule 98
:
Definitions
Rule 99
:
Establishment of fund and trust
Rule 100
:
Conditions regarding trustees
Rule 101
:
Investment of fund moneys
Rule 101A
:
Nomination
Rule 102
:
Admission of directors to a fund
Rule 103
:
Ordinary annual contributions
Rule 104
:
Initial contributions
Rule 105
:
Penalty if employee assigns or charges interest in fund
Rule 106
:
Employer not to have interest in fund moneys
Rule 107
:
Arrangements for winding up, etc., of business
Rule 108
:
Arrangements for winding up of the fund
Rule 109
:
Application for approval
Rule 110
:
Amendment of rules, etc., of fund
Rule 111
:
Appeal


Summary of Rules applicable for Gratuity Fund
1.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.   A 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; B the trust money shall be invested in such trusted securities as are payable both as regards capital and interest in India; C the gratuity shall be made payable and shall be paid only in India; D the trustees shall be responsible for deduction of tax from the gratuities and crediting the tax so deducted to the Government revenue; E 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; F 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
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 81/3 per cent of the employees’ salary for each year of his past service with the employer.
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 81/3 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 employee’s 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).