Why Accounting and Funding for Gratuity Benefits is compulsory for Companies on or before end of each Financial Year ?

This article is an attempt to give information about requirement of Accounting and Funding for Gratuity Benefits for Companies on or before end of each Financial Year.

1. An Overview Gratuity Benefits

Gratuity benefits are governed by "The Payment of Gratuity Act 1972" and paid by the Company to an employee in addition to his salary on exit from the company. Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal Benefit.The cost is to be borne by the Company and not by an employee. Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years: -

(a) on his superannuation, or

(b) on his retirement or resignation, or

(c) on his death or disablement due to accident or disease:

Provided that the completion of continuous service of 5 years shall not be necessary where the termination of the employment of any employee is due to death or disablement.

2. Calculation of Gratuity Benefits

Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal benefit. It means, Gratuity amount will be determined when monthly terminal wages of the employee are known to the company. The terminal wages will include Basic & Dearness allowance only. The Gratuity Benefits are calculated using the following formula:-

(15/26) MULTIPLIED BY (No of Completed Years on Exit) MULTIPLIED BY (Terminal Wages)

The Gratuity Benefits are subject to a ceiling limit of 20 Lakhs or as prescribed by the company.

3. Factors affecting Quantum of 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,

You may visit my article published at www.taxguru.com for understanding impact of the above Factors on Gratuity Benefits. The web-link for the article is as under :- https://taxguru.in/income-tax/factors-affecting-gratuity-benefits-accounting-taxation-gratuity-benefits.html

4. Legal Provisions on Employer under Payment of Gratuity Act 1972 (Amended)

Section 7 of the Act has kept the obligation for payment of gratuity act on the shoulders of the employer, few provisions of the act are listed below:-

i. As soon as Gratuity becomes payable, it employers responsibility to determine the amount of gratuity and inform it to an employee in writing (Refer subsection 2 of Section 7 of the Act).

ii.  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).

iii.  If the amount of gratuity is not paid within 30 days then the 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).

 5. Accounting & Funding Options for Gratuity Benefits

 Gratuity Plan falls in the category of Defined Benefit and it increases exponentially with the increase in wages of employee and service period of the employee & it is employers responsibility to pay the gratuity to the employee in any case. Companies have generally 2 options for discharging the Gratuity Liability: -

 1. Accounting Option – In this option Provision of Gratuity is made in Financial Statement of the Company by taking Actuarial Valuation Report/Certificate  from the Actuary and whenever employee leaves the company. Company pays the gratuity from their own resources. This option is also called "Pay as you go Option". This option is mandatory for all companies having 10 or more companies due to regulatory provisions of Section 133 of Companies Act 2013 for compliance of Accounting Standards whilst preparing the Financial Statements at the end of each Financial Year (i.e. 31.03.2020).

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.):-

                a. AS 15 (Revised 2005)

               b. IndAS 19

               c. IAS 19 (Revised 2011)

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

(i) SME COMPANIES - In this case, company needs to disclose details as required for Clause (l) of Para 120 of AS 15 (Revised 2005)

(ii)  NON - SME COMPANIES - In this case, company needs to disclose details as required for Para 120 of AS 15 (Revised 2005)

(iii)  COMPANIES WITH NET-WORTH MORE THAN 250 CR. - In this case, companies and their subsidiaries has to give disclosure of in compliance of IndAS 19 with comparative numbers of previous 2 years.

(iv) MULTINATIONAL COMPANIES - In this case MNC'S requires to comply with IAS 19 (Revised 2011) & US-GAAP for provisioning of Defined Benefit Plans in their Financial Statement for consolidated provisioning in Financial Statement of their International Group Companies.

2. 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. 

 Due to taxation benefits available to Companies in Funding Option, Companies prefer to manage Gratuity Liability through an Approved Gratuity Trust. There are 2 ways of investment of Trust money :- 

 A. Investment of Trust Money by Trustees. 

B. Investment of Trust money into Group Gratuity Scheme of Insurer by Trustees.

 (Please note that in both cases 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)) 

 The establishment of Gratuity Trust & Accounting of Employee Benefits Valuations requires in-depth knowledge of various rules/regulations and expertise. We have a team-leading Professionals, Litigation Partners, Chartered Accountants, Company Secretaries & Heads of Insurance Companies having decades of experience in providing their 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 offer paid online/offline End to End Support Services for the following :-

 1. Consultancy Services for Formation of a New Approved Irrevocable Gratuity Trust,

2. Consultancy Services for Approval of Gratuity Trust from Authority,

3. Consultancy Services for Group Gratuity Schemes of Insurers,

4. Consultancy Services for Investment of Privately Managed Gratuity Trusts,

5. Consultancy Services for Investment of Employer-Employee Schemes,

6. Consultancy Services for Retention Policies,

7. Support Services for Actuarial Valuations in compliance of AS 15 (Rev. 2005), IndAS 19 & IAS 19-IFRS

8. Support Services for Fair Value Valuations in compliance of IndAS-113, IndAS-36, IndAS-103, IndAS-109 IndAS-28, IndAS-38, IndAS-102 & IndAS-16.

For more details or Consultation/Advise on the above matter, you may contact me at 9211637063 or email me your queries at [email protected]

 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)

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