Applicability of Gratuity :
As per the payments of Gratuity Act 1972, Gratuity is applicable to employees engaged in factories, mines, oilfields, plantations, ports, railway companies, shops, or other establishments with 10 or more employees or/were employed on any day in the preceding twelve months. Gratuity is fully paid by the employer.
The Karnataka government officially introduced the Karnataka Compulsory Gratuity Insurance Rules, 2024 (“Gratuity Rules” or “Rules”) on January 10, 2024. These rules are in conjunction with Section 4-A of the Act, which mandates that employers procure insurance to cover their gratuity obligations to employees and obtain proper registration for this purpose. It’s important to note that even if an employer’s workforce falls below 10 employees, gratuity remains mandatory once the Act applies. Furthermore, it’s essential to emphasize that gratuity payments do not come from employees’ salaries.
Registration and compliance requirement under the rules:
Under the Rules, employers falling within their scope must adhere to specific registration and compliance requirements:
- Registration Process: Employers must submit an application for the registration of their establishment to the Controlling Authority, which is the Labour Commissioner or Officials authorized by the Labour Commissioner. This application must be in the prescribed format and submitted within 30 days of obtaining insurance (using Form I). The application should include details such as the number of insured employees, the name of the insurance company, insurance policy reference numbers, and the terms governing insurance policies.
- Recording Changes: Employers must also submit prescribed forms (Form III) to the Controlling Authority in case of any changes, such as alterations in insurance policies, modifications in employee details or numbers, or any other relevant information. These changes should be promptly recorded with the Labour Commissioner or Officials authorized by the Labour Commissioner.
- Premium Payments and Renewals: Employers with valid insurance policies are obligated under the Rules to ensure timely premium payments to the insurance company and to renew policies periodically. It is the responsibility of the employer to initiate the premium payment and policy renewal process before the current policy lapses.
The requirement of obtaining an Insurance Policy in accordance with Rule 3 are summarized as follows:
Timeline for registration
New Employers: All new employers are required to obtain an Insurance Policy with correct validity within 30 days from the date on which these Rules become applicable (i.e., no later than 30 January 2024) either from the Life Insurance Corporation of India (“LIC”); or any other insurance company incorporated in accordance with any other law applicable to such insurance companies.
Existing Employers: All existing employers of already operating establishments have to acquire a valid insurance coverage within 60 days from the date of commencement of these Rules (i.e., no later than 9 March 2024).
Payment, reporting responsibilities, and powers of the controlling authority:
The responsibilities and powers concerning payment, reporting, and authority of the Controlling Authority are outlined as follows:
- Premium Payments and Renewals: Employers must ensure timely payment of premiums and regular renewal of policies.
- Reporting Changes: Employers must promptly notify the Controlling Authority of any changes within 15 days of policy renewal.
- Dispute Resolution and Authority: In the event of disputes, the Controlling Authority designated under the Payment of Gratuity Act, or any other officer appointed by the state government, is vested with the authority to recover gratuity owed to employees. This recovery can be pursued from the Life Insurance Corporation of India (LIC) or any other insurance company that provided the insurance coverage.
Exemptions:
Exemptions under the Rules are provided for:
1. Employers who have established an approved Gratuity Fund and intend to maintain this arrangement.
2. Employers with 500 or more employees, who establish an approved Gratuity Fund, are exempted from mandatory gratuity insurance under certain conditions:
a) They must submit an application using the prescribed form (Form II).
b) The existing approved Gratuity Fund must cover the entire liability for all employees of the establishment.
c) These exempt employers must register a gratuity trust with five representatives, comprising a mix of employers and employees, with the registration authority specified under the Indian Trust Act, 1882.
Additionally, to qualify for gratuity under the Gratuity Act, an employee typically requires a minimum of five full years of service with the current employer. However, in cases where an employee passes away or becomes disabled due to accident or illness, gratuity must still be provided.
Gratuity is paid when an employee:
- Is eligible for superannuation
- Retires
- Resigns
- Passes away or is rendered disabled due to accident or illness (if an employee passes away, gratuity will be paid to the employee’s nominee)
Exemptions on gratuity received: Sec 10(10) of Income Tax Act 1961
Government Sector Employees:
> The gratuity given to employees working in a government sector upon their termination, retirement or superannuation are fully exempted from paying tax. It is applicable to employees of the central government, state government, defense sector, members of civil services and other local authorities.
Private Sector Employees covered under Payment of Gratuity Act 1972 :
> The income tax exemption on gratuity received is the least of the following three:
a) Gratuity amount of Rs 20 lakhs
b) Last 15 days salary (consider no. of days in a month to be 26) number of years of employment
c) Actual gratuity received
Private Sector Employees not covered under Payment of Gratuity Act 1972 :
> The income tax exemption on gratuity received is the least of the following three:
a) Actual gratuity received
b) Gratuity of Rs 20 lakhs
c) Last 10 months average salary x number of years of employment x 1/2
Note:
- 15 days salary based on the salary last drawn for every completed year of service or part thereof i.e. 15/26.
- Number of years in service is rounded off to the nearest full year.
- Salary = Basic + DA
Tax Implications on Employers
Section 36(1)(v) provides a tax deduction for payments made towards an approved gratuity fund created by the employer exclusively for employees, under an irrevocable trust. However, this is subject to Section 43B(b), which permits certain deductions only on a payment basis.
Based on these two sections it is clear that a provision for gratuity is not allowed as tax deduction unless it is paid.
Under Section 40A(7), clause (a) stipulates that no tax deduction will be granted for any provision made by the assessee for gratuity payments to employees, whether due to retirement, termination, or any other cause. However, clause (b) counters clause (a) by indicating that clause (a) would not apply if the assessee makes provision for contribution towards an approved gratuity fund, or for gratuity payments that became payable in the preceding year.
Example
1. Consider the case of Mr.X, a 15-year employee of ABC Company. Upon his retirement during the current year, Mr.X receives his gratuity, despite ABC Company not maintaining a gratuity fund. In this situation, the gratuity payment is deductible in the current year.
2. In a slightly different scenario, assume a portion of Mr. X’s gratuity is paid during the current year and the remainder is provisioned to be paid next year. The entire amount is still allowed as a current year deduction, even though it’s directed towards an unapproved gratuity fund since it became payable within the year.
3. XYZ pvt ltd that employs 50 workers. The company established a gratuity fund and makes yearly contributions to offset future gratuity liabilities. Such contributions qualify for deductions only if the gratuity fund is approved.
No Clarification on:
Now the real difficulty arises with whether payments to insurers now as per the Notification dated 10 January 2024, the Government of Karnataka notified the Karnataka Compulsory Gratuity Insurance Rules, 2024 (“Gratuity Rules” or “Rules”) to be read with Section 4-A of the Act, would be allowed as deduction in Income tax computations?
Conclusion: The introduction of Karnataka’s Gratuity Insurance Rules 2024 marks a significant change in gratuity management for employers. Compliance with registration, insurance, and reporting requirements is essential to avoid penalties and ensure employee welfare. Employers must also navigate the tax implications of gratuity payments and seek clarification on deductions related to insurance premiums. By understanding and adhering to these rules, employers can mitigate risks and maintain legal compliance while safeguarding employee interests.
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