Increasing Employee Benefits Liability in India.

India has Many Employee Benefit schemes but few schemes which are common and used across corporates are Gratuity, Pension and Leave encashment.

EMPLOYEES’ GROUP GRATUITY SCHEME

Payment of Gratuity Act, 1972:

The payment of a gratuity to employees upon cessation of service is a statutory obligation imposed on employers by the Payment of Gratuity Act, 1972. In terms of the Act, gratuity is 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 5 years is not, however, necessary for payment of gratuity in case of death or disablement). The gratuity is to be calculated at the rate of 15/26th of a month’s wages for every completed year of service or part thereof in excess of six months, subject to a maximum of INR.3,50,000/-.

Effective 24th May 2010, the gratuity limit has been revised from INR 3,50,000/- to INR 10,00,000/-. A circular to this effect has been attached alongwith for your reference (Annexure I).The same has been further revised to 20 Lacs with effect from 29th March 2018.

Nature of the liability:

The amount of gratuity payable depends upon the terminal salary of the employee and the number of years of service completed by him. Since the liability keeps on increasing with the completion of every year of service and with the grant of every increase in salary, sound financial principles demand that necessary funds are set apart in advance year after while the liability is accruing. Otherwise, it may happen that too many employees with large gratuity entitlement leave service in some future year or years, when large additional funds will have to be found for disbursement of the gratuity.

Therefore, the method of pay-as-you-go is likely to prove troublesome to the employer, in the future year(s).

Important Factors That would impact Gratuity Liability and increase business Potential for insurance Companies.

1.      7th pay commission and revision of Salary for PSE/PSU and Government Employees.

2.       Gratuity Ceiling Further Going Up from 10 Lacs.

3.      Applicability of Compulsory Gratuity Funding

4.      Movement of companies from Tax Free zones. (SEZ)

5.      Equity Ceiling in self-Managed Trusts.

 7th pay commission and revision of Salary for PSE/PSU and Government Employees-   Government of India Has already proposed 7th Pay commission and shall be effective from January 1, 2016. Ministry of Labor is evaluating various options and are in constant discussion with various PSU and PSE Bodies. Once the same will be applicable Liabilities of PSU/PSE and State PSUs would shoot up. It will also give a push on revision of salaries in Banks. As Gratuity is a statutory liability many companies likes to fund this with insurance companies. With the awareness going up and Insurance companies giving better services many PSU/PSE & State PSUs have already outsourced to Pvt insurance companies. Once the commission roles out It will immediately shoot up business potential and opportunities and will be immense. Post 6th Pay commission only 3 companies viz BSNL, IOCL and ONGC Paid INR 14500 Crores towards past liabilities to Insurance Companies.  The liabilities may be in tune of 40-50 K Crores.

 Gratuity Ceiling Further Going Up from 10 Lacs- In 2010 Gratuity Cap was increased from 3.5 lacs to 10 Lacs. However due to increased salaries many top executives in both Pvt and Govt Companies fall beyond this bracket and thus losing a huge amount of Gratuity. In various zero hours session of Parliament the matter has been taken up by various MPs. One MP from Orissa has already filed a bill to increase the ceiling and make it unlimited. Labor Unions like CITU, BMS, AITUC and HMS has deliberated upon this with ministry of labor and has raised on various forums. Few PSUs like SAIL and IOCL are already paying full gratuity after deducting salaries. It is thus imperative that Gratuity ceiling would surely go up in times to come thus increasing the liabilities for various companies. It will thus enhance business potential as well.

  Applicability of Compulsory Gratuity Funding - Government of Andhra Pradesh vide its Gazette Notification Lr.No.M1/8842/2010, dated: 04.12.2010 from the Commissioner of Labour, Andhra Pradesh. Dated 4th March 2011 has notified to make Gratuity Funding Mandatory. Though companies have options to keep funds self-managed considering the nuances of self-managed funding most companies would opt to outsource with Insurance companies and thus would increase business potential for them. There is a huge probability of other states also taking cues from the same and make the same applicable in their state or Ministry of Finance making it mandatory across the country once the proposal is sent to them for review. This may happen once the revised gratuity bill is discussed in parliament.

Movement of companies from Tax Free zones. (SEZ) -  Many Large MNCs who came to India post Liberalization will be out of tax holidays by end of 2015. It would thus be imperative for them to fund for Gratuity to save taxes. Many Large Multinationals operating out of these zones are already evaluating options and may fund in next 1-2 years. This will give a great boost to business of Insurance companies for Gratuity and liabilities would be in tune of 800-100 Crores.

Equity Ceiling in self-Managed Trusts- With the change in pattern of investment by ministry of finance vide its circular number 11/15-2013-PR self-managed trusts are mandated/directed to invest in equities. The minimum that they should invest is 5% and can go up to 15%. However for self-managed funds which are not well equipped to trade on a regular basis will not want to take risks on their own considering the volatilities of market. They would thus either want to invest in a mutual fund or outsource it to an insurance companies. Outsourcing to an insurance companies will further mitigate their risk as they would not be necessarily required to expose to equity risks or in other case they would have a hybrid fund with mix of debt and equities which would give them a more consistent returns. 

II. EMPLOYEES’ SUPERANNUTION SCHEME

Need for Superannuation Scheme:

As an employer the company is currently contributing 12% of each employee's salary into the (EPF) Employees Provident Fund Scheme. But is it sufficient to provide an adequate retirement income for your employees?

The answer to this question is unfortunately NO. There are two main reasons:-

Firstly, employees have the option to withdraw assets from the Provident Fund on a regular basis to meet ongoing lifestyle expenses. Most of your employees will reach retirement age with an inadequate balance to purchase an income stream to provide them a reasonable income on retirement.

The second reason is that employees are now retiring younger but are living longer. Therefore the capital they need to buy an income stream is much greater than ever before, and this increase in life expectancy will continue to grow making this gap even greater.

Types of Superannuation Scheme:

It is primarily of two types: Defined Benefit (DB) & Defined Contribution (DC)

Under the DB scheme, the benefit which the employee shall receive post his retirement is fixed in advance (say a % of his last drawn salary), so, if the superannuation rules of the company state that the employee will get 30% of his last drawn basic salary as his pension amount, then his benefit on retirement has been defined in advance.

Under the DC scheme, the employer decides what % to contribute to the superannuation fund in the name of the member/employee right from the person's joining. Thus the employee/company may decide to contribute an 8% or a 10% depending on what it deems fit. It might also be the case the co. might decide to make a higher contribution for an employee who has stayed with the co. for more than 10 yrs and less for an employee who has stayed with the co. for say 5 years. It can hence be used as a retention tool.

The Superannuation Scheme can thus be contributory (employer & employee both contribute) or non-contributory (only employer contributes).

How is the scheme maintained by the insurer?

Under a superannuation scheme, each employee's/member's account is maintained separately with the life insurance co., stating what is the contributions made to that account (say X) and the amount of interest earned on the same (say Y).

On his retirement, out of the total accumulated amount in his account (i.e. X + Y), he can commute 1/3 rd of the total accumulation (this commuted amount is tax free) and the balance 2/3 rd can be used to purchase annuities/monthly pensions (taxed at the pensioner's income-tax bracket).

Important Factors That would impact Superannuation Liability and increase business Potential for insurance Companies.

·        7th pay commission and revision of Salary for PSE/PSU and Government Employees.

·         DPE guidelines on setting up of New Superannuation schemes

·        Movement of companies from Tax Free zones. (SEZ)

·        Equity Ceiling in self-Managed Trusts.

·        7th pay commission and revision of Salary for PSE/PSU and Government Employees.  With increased salaries the past and contribution liabilities in contributory schemes of SA will immediately go up. It would thus give lot of opportunities for Insurance companies to dent into this space and will open new avenues in terms of opportunities.

·        DPE guidelines on setting up of New Superannuation schemes-  Directorate of Public enterprises has already notified to all PSU/PSE to set up a defined contributory scheme for its employees. While many PSUs have already set up a scheme many are still in discussion and consultation with their respective ministries. This has already given lot of boost to pension business of Insurance companies and will add up to the potential once remaining ministries also approve it.

·        Movement of companies from Tax Free zones. (SEZ Movement of companies from Tax Free zones. (SEZ) which will fall into tax bracket starting January 16, Pension scheme would be an important mean to retain employees and save taxes at the same time. Section 36 1 (V) of IT acts specifies all contribution made to pension schemes to be treated as business expense and thus not pay any taxes. Many companies may revise the payment structure of their employees and make pension as part of their CTC thus making it a retention tool as well as tax saving tool.

·        Equity Ceiling in self-Managed Trusts - With the change in pattern of investment by ministry of finance vide its circular number 11/15-2013-PR self-managed trusts are mandated/directed to invest in equities. The minimum that they should invest is 5% and can go up to 15%. However for self-managed funds which are not well equipped to trade on a regular basis will not want to take risks on their own considering the volatilities of market. They would thus either want to invest in a mutual fund or outsource it to an insurance companies. Outsourcing to an insurance companies will further mitigate their risk as they would not be necessarily required to expose to equity risks or in other case they would have a hybrid fund with mix of debt and equities which would give them a more consistent returns. 

III. EMPLOYEES’ LEAVE ENCASHMENT SCHEME

Need for Leave Encashment Scheme:

As an acknowledgement of an employee’s loyalty, the employer may choose to offer them leave encashment benefits. Leave encashment is the amount payable for the employee’s accumulated leave period, depending upon the leaves to his credit and his salary at the time of termination of employment. This amount may be paid to the employees (or to their dependents) on retirement, death or disability.

Leave encashment liabilities’ increase over time, with the increase in an employee’s years of service and salary. Such leave encashment could be a huge liability to the company.

An effective and well-managed Group Leave Encashment Plan will help reduce the financial strain on the employer by helping them systematically fund their leave encashment liabilities payable to employees.

According to the Accounting Standard (AS-15) of January, 1995 and amended Section 209 (3) of Companies Act, 1957, it has become necessary for employers to provide for the liability of leave encashment facility available to employee in the annual books of accounts.

Taxation benefits of having an insurer funded Leave Encashment Scheme:

1

Leave encashment received at the time of retirement is fully exempt in the case of Government Servants. In the case of non-Govt. Employees, leave encashment is exempt to the extent of the least of the following four amounts: -

·            Rs. 3,00,000/-

·            Ten months' average salary; 

·            Cash equivalent of the leave due at the time of retirement;

·            Leave encashment actually received at the time of retirement.

(Here the average salary means the average of the salary drawn during the last ten months before retirement)

Section 10 (10 AA)

2

The cash equivalent of the leave Encashment Benefit as and when paid by the employer is deductible from his income

Section 37(1)

3

For the Employee, the leave encashment benefit is taxable.

Leave encashment while in service is taxable.

Encashment of sick leave is taxable.

Section 15

While the current tax laws are not very favorable to set up a LE Scheme. In case the tax laws are revised and LE is also brought under either Section 36 or Section 43 thus allowing funding of these benefits as tax free It will give a great boost to insurance business.