Payment of Gratuity to Employee: Employers liability & Income Tax Perspectives
One of the important liabilities of the employer having more than 10 employee is a liability towards Gratuity. Let us know more about it in the simple possible mode as under:
- Payment of Gratuity benefits to employee is governed by “The Payment of Gratuity Act 1972” and paid by the Company to an employee. This is over and above the regular salary to employee.
- It is payable at the time of exit from the company.
- Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal.
- Gratuity amount is determined only on the monthly terminal wages of the employee on his exit from the Company after rendering of 5 years of Service.
- Gratuity cost is to be borne by the Company and not by an employee and it cannot be the part of the CTC of the employee for its calculation. In short, it has to be considered as an additional cost of the employer.
- Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than 5 years
(a) on his superannuation, or
(b) on his retirement or resignation, or
(c) on his death or disablement due to accident or disease.
- Completion of continuous service of 5 years shall not be necessary if the termination of the employment of any employee is due to death or disablement.
- Gratuity is a statutory right of employee and is a terminal benefit.
- Gratuity amount will be determined when monthly terminal wages of the employee are known to the company & terminal wages will include Basic & Dearness allowance only. Gratuity amount is to be calculated at 15 days for every completed year of service wherein month is taken of 26 days. The calculation of the Gratuity Benefits shall be as under:
Gratuity = (15 Days divided by 26 days in a month) /26) Number of Completed Years on Exit Terminal Wages
- In short, Gratuity Benefits provision from employer’s perspective will change year on year basis & will be dependent on the following factors:
(a) Number of years of Employee service with the employer
(b) Wages of Employee at the time of retirement or leaving the company,
(c) Timing of leaving the employment by the employee
(d) Number of employee leaving the company within the time barred period of 5 years
(e) Increments offered from time to time
(f) Amendment in the Gratuity Act from time to time.
- The obligation for payment of gratuity act on the shoulders of the employer under section 7 of the Gratuity Act. Various sub sections mentioned as under:
i. When the Gratuity becomes payable, it is employer’s responsibility to determine the amount of gratuity and inform it to an employee in writing,
ii. Employer shall make an arrangement to pay the amount of gratuity within 30 days from the date when it becomes mandatory.
iii. If for any reason whatsoever, gratuity is not paid within 30 days then the amount of gratuity along with simple interest thereon will be paid by the employer to the employee for the duration when the payment is not made to the employee.
- Making provision for gratuity is a tough task for the employer.
- The best option for an employer could be either to opt for the gratuity plan offered by the insurance companies or to create own trust for the provision of payment of gratuity to the employee.
- As far as deduction of provision for gratuity is concerned, it may be noted that provision of Gratuity on accrual basis which though may be based on actuarial report is not allowable as deduction under the provision of Income Tax Act 1961.
- To overcome this, companies can create a Gratuity Trust as there are tax benefits that are involved in creation of an irrevocable trust for the benefit of the employees by the business houses. At the first instance, provision & contribution of Gratuity on accrual basis by the employer into an Approved Gratuity Trust is allowed as deduction u/s 36(1)(v) of the I.T. Act -1961 subject to compliance of the condition specified in Income Tax Rules 103 & 104. More interestingly, any Interest received from Investment of an Approved Gratuity Trust is also exempted as Income Tax u/s 10(25) of the Income Tax Act, 1961.It must be remembered here that approval of Gratuity Trust in terms of Part C of the Forth Schedule to the Income Tax Act, 1961 is mandatory for organizations to get benefits under Section 36 (1) (v) & Section 10 (25) (iv)