This article delves into the world of Approved Gratuity Trust, providing an overview, benefits, formation process, and key compliance aspects.
Approved Gratuity Trust
As mentioned in our article about Overview of Gratuity there are two ways of booking the expense under Gratuity scheme which is Traditional method and Approved Gratuity Trust. In this article, we will discuss briefly about Approved Gratuity Trust.
- Gratuity Trust is set up for providing gratuity benefits to the employee’s trust. This acts as a separate legal entity.
- Gratuity Trust is set up as an irrevocable trust. Irrevocable means it cannot be changed, reversed or recovered.
- Gratuity is accrued in the books based on AS-15 based on an actuarial valuation.
Traditional method v/s Group Gratuity Scheme
||Group Gratuity Scheme
|Here, there is no separate fund or trust has been made
||Here, there is a separate fund, trust or like arrangement has been made
|Here, assets are not backed to set aside liabilities
||Here, assets are backed to set aside liabilities
|Here, the amount of gratuity is given to employees at the time of their retirement or resignation
||Here, certain amount of funding is yearly made to the trust.
|This is a disallowable expense as per the Income Tax Act
||Contribution made to Group Gratuity Trust is a allowable expense under Income Tax Act
Advantages of Group Gratuity Scheme
- Tax benefits at 25.17% of the amount contributed in the Group Gratuity Trust. Contributions to an approved Gratuity fund is deductible under section 36 (1)(v) of the Income Tax Act,1961. The carefully planned funding strategy of Easy Accounting can significantly reduce the tax bill of a company.
- When the company have approved gratuity trust, they need to give cash from within the business and commit it to a trust. So, the most important consideration is the alternative ways where the cash could be invested and return which could be received and even for how long it be received. So, now the point to be remembered is that the interest earned within a gratuity fund is tax free. Therefore, an expected return of 10% p.a. is equivalent to apporox 13-14% p.a. pre-tax return.
- In case of unfunded, the company need to pay gratuity as and when the employee leaves. So there is huge amount of uncertainty on the amount of gratuity paid every year. In case of funded, there is no sudden cash flow at the time of retirement or resignation. So there is certainty on the amount contributed to the trust every year.
- By having the liabilities funded, companies can replace the rapidly increasing gratuity payouts with a relatively stable stream of contributions into the fund.
- Easy Accounting will invest their chosen funds. Income earned through that investment is exempt from income tax.
- It creates a trustworthy relationship with the employees.
Tax benefits on Formation of Trust
- The contribution made by the employer is an allowable expense under Income Tax Act
- Income received from the gratuity trust shall be exempt under Section 10(25)(iv) of the Income Tax Act,1961.
- Interest received from Investment of an Approved Trust is also exempted as Income under Section 10(25)(iv) of the Income Tax Act,1961.
Steps for formation of Trust
1. Firstly, the company determines an initial contribution which would be made by them into the Gratuity Trust
2. Then the management need to appoint at least two trustees as per the Income Tax Rules, 1962.
3. Then prepare the Trust Deed and collects all the required documents .
4. After the finalisation of Trust deed and rules and getting all the documents required, an Bank Account is opened in a Scheduled Bank as mentioned in Rules of Income Tax Rules,1962.
5. Then the trustees have to make decision for investment of Gratuity Fund which would be done by themselves or they will approach an insurance company.
6. After this, we need to get approval from Income Tax Department so that the Gratuity Trust becomes an Approved Gratuity Trust.
Contributions to Trust
- Companies expected to contribute every year certain amount of fund in Gratuity Trust.
- There is no minimum amount to be contributed by the employer into the Gratuity Trust.
- Employer could get tax benefit from the amount contributed by them into the Trust.
- In case the amount in the Gratuity Trust exceeds the amount paid as Gratuity in a financial year, the extra amount shall remain in the fund.
- In case the amount paid as Gratuity shall exceed the amount in the Gratuity Trust, the remaining amount shall be paid by the employer.
Investment by Trust
- Once the Trust is made then the contribution received from Company is invested in chosen funds of insurance companies.
- Company can invest in different debt and equity products offered by insurance companies.
Process at Retirement/ Resignation
- The employee must send their application to the employer including all the details about him/her and also specify the gratuity amount owned by him/her.
- After receiving application, company also calculates the gratuity amount and sends notice to employee with the specified amount.
- After receiving acknowledgement, the employer has to pay gratuity within 30 days.
Documents Required for formation of Trust
- Copy of PAN Card
- Copies of Audited Financials and ITR of Employer for the latest available three years
- List of all the offices and branches of the Employer
- List containing the details of Employees of the Employer
- Name and address of the trustees
Q.1 What is the time taken to do the formation of the trust?
- Creation and execution of the Trust deed – 5-10 days
- PAN Card application – Within 5 days from the execution of trust deed
- Bank account: Around 15 days from the date of receipt of PAN card
- Process for Income Tax Approval: Around 4-6 months from the date of execution of Trust Deed
Q.2 Who can be the trustees of the company?
Ans. The power of appointing trustees lies in the hand of Company. Trustee should be a resident of India. A company can also be appointed as a Trustee but only on the approval of Chief Commissioner or Commissioner. Even the directors of the Company could be trustees of the Company.
Q.3 Can there be any change done in Trust Deed?
Ans. While getting approval from Income Tax, the Income Tax Department ask to do some changes in the Trust Deed. So those changes need to be done to get the approval of Trust Deed. For the purpose of variation in the original Trust Deed, Deed of Variation is made.
Q.4 Where should we invest money in the Trust?
Ans. Easy Accounting will help in advising between different debt and equity products offered by Insurance Companies. Companies can self manage the trust or invest in LIC or private companies.
Q.5 Is gratuity provision required even if employee has not completed five years?
Ans. Yes even if employee has not completed five years provision for gratuity should be made in books of accounts.