This is article is in continuation with my previous article Gratuity Payment under Social Security Code 2020 wef 01.04.2021, in my previous article we have discussed about the difference between the Old provisions of the Payment of Gratuity Act 1972 (a) and New provisions of Social Security Code 2020 to be effective from 01.06.2021 on companies operating in India with employee strength more than 10. In this article we will discuss about the impact of new provisions of Social Security Code 2020 on Gratuity Benefit on Financial Statements of Indian Companies.
New Provisions to be effective from 01.06.2021 under the Code of Social Security 2020 – (Refer Section 53 (1) of The Social Security Code 2020
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; or
(d) on termination of his contract period under fixed term employment; or
(e) on happening of any such event as may be notified by the Central Government
Provided that in case of working journalist as defined in clause (f) of section 2 of the Working Journalists and Other Newspaper Employees (Condition of Service) and Miscellaneous Provisions Act, 1955, the expression “five years” occurring in this sub-section shall be deemed to be three years:
Provided further that the completion of continuous service of five years shall not be necessary where the termination of the employment of any employee is due to death or disablement or expiration of fixed term employment or happening of any such event as may be notified by the Central Government:
Provided also that in the case of death of the employee, gratuity payable to him shall be paid to his nominee or, if no nomination has been made, to his heirs, and where any such nominees or heirs is a minor, the share of such minor, shall be deposited with the competent authority as may be notified by the appropriate Government who shall invest the same for the benefit of such minor in such bank or other financial institution, as may be prescribed by the appropriate Government, until such minor attains majority
Determination of Gratuity Amount – (Refer Section 53 (2) of The Social Security Code 2020
For every completed year of service or part thereof in excess of six months, the employer shall pay gratuity to an employee at the rate of fifteen days’ wages or such number of days as may be notified by the Central Government, based on the rate of wages last drawn by the employee concerned. The formula for calculation of Gratuity for such employees will be: –
For Regular Employees
(Wages of the employee at the time of exit) x (15/26) x (Number of Years of Service at the time of exit)
Provided that in the case of a piece-rated employee, daily wages shall be computed on the average of the total wages received by him for a period of three months immediately preceding the termination of his employment, and, for this purpose, the wages paid for any overtime work shall not be taken into account:
Provided further that in the case of an employee who is employed in a seasonal establishment and who is not so employed throughout the year, the employer shall pay the gratuity at the rate of seven days’ wages for each season. The formula for calculation of Gratuity for such employees will be: –
For Seasonal Employees
(Wages of the employee at the time of exit) x (7/26) x (Number of Years of Service at the time of exit)
Provided also that in the case of an employee employed on fixed term employment or a deceased employee, the employer shall pay gratuity on pro rata basis. The formula for calculation of Gratuity for such employees will be: –
For Fixed Term Employees
(Wages of the employee at the time of exit) x (15/26) x (Pro Rated Fraction & Completed Year of Service at the time of expiration of term of employment)
Major Changes
After analyzing the new provisions of Chapter 5 of Social Security Code, 2020, it is observed that following changes will cause exponential rise in provisions of gratuity liability in the Financial Statements (i.e Balance Sheet, OCI & Profit/Loss, etc.) of the Companies: –
1. Change in Definition of Wages,
2. Change in Vesting Condition for Fixed Term Employees,
3. Change in Vesting Condition for Working Journalists and Other Newspaper Employees,
4. On happening of any such event as may be notified by the Central Government,
5. Compulsory Gratuity Insurance.
6. The impact of the above Factors on Gratuity Benefits can be understood by the following Examples:
Point I – Change in Wages
This change will affect the Financial Statements of the companies, where the Wages are less than 50% of monthly CTC. Let us take an example to understand this change. Say Mr. A is Regular Employee and has completed 5 years of Service with Company ABC and his Wages for computation of Gratuity as on 31.03.2021 is Rs. 2,70,000/- per month which 30% of Monthly CTC Salary (i.e., Rs. 9,00,000/-), Now Gratuity Payable by the company to Mr. A under the provisions of the Payment of Gratuity Act 1972 (a) will be: –
| Gratuity Payable on 31.03.2021 | (15/26) *(5) *(2,70,000/-) | Rs. 7,78,846/- |
After change in the Definition of Wages under the new provisions of Social Security Code 2020, now new wages of Employee A will be: –
| Total Monthly CTC | Rs. 9,00,000/- |
| New Wages (i.e., 50% of CTC) | Rs. 4,50,000/- (i.e., 9,00,000 * 0.50 = 4,50,000/-) |
Now Gratuity Payable to Employee A with new wages as on 01.04.2021 will be: –
| Gratuity Payable on 1.04.2021 | (15/26) *(5) *(4,50,000/-) | Rs. 12,98,077/- |
Total Impact due to change in Wages will be Rs. 12,98,077/- minus Rs. 7,78,846/- equals to Rs. 5,19,231/-
Point II & III – Change in Vesting Condition
This change will affect the Financial Statements of the companies where contractual or fixed term employees are hired for a task such IT & Engineering Companies. Let us take another example to understand how change in vesting condition will affect the Financial Statements of IT, Engineering & Companies where mostly Fixed Term Employees are employed.
Let’s Say Mr. A is Fixed Term Employee and working in company from last 5 years with Company ABC and his Wages for computation of Gratuity for last 5 years is Rs. 2,70,000/- per month which 30% of Monthly CTC Salary (i.e., Rs. 9,00,000/-).
Now Gratuity Payable by the company to Mr. A when he resigns the company before 5 years under the provisions of the Payment of Gratuity Act 1972 (a) will be: –
| if Employee A leaves the company after completing year 1 | (15/26) *(1) (2,70,000/-) | NIL |
| if Employee A leaves the company after completing year 2 | (15/26) *(2) (2,70,000/-) | NIL |
| if Employee A leaves the company after completing year 3 | (15/26) *(3) (2,70,000/-) | NIL |
| if Employee A leaves the company after completing year 4 | (15/26) *(4) (2,70,000/-) | NIL |
| if Employee A leaves the company after completing year 5 | (15/26) *(5) (2,70,000/-) | Rs. 7,78,846/- |
After Implementation of New Provisions of Chapter V of Social Security Code 2020, Gratuity Payable by the company to Mr. A when he resigns the company in 5 years will be:-
| if Employee A leaves the company after completing year 1 | (15/26) *(1) *(4,50,000/-) | Rs. 2,59,615/- |
| if Employee A leaves the company after completing year 2 | (15/26) *(2) *(4,50,000/-) | Rs. 5,19,231/- |
| if Employee A leaves the company after completing year 3 | (15/26) *(3) *(4,50,000/-) | Rs. 7,78,846/- |
| if Employee A leaves the company after completing year 4 | (15/26) *(4) *(4,50,000/-) | Rs. 10,38,462/- |
| if Employee A leaves the company after completing year 5 | (15/26) *(5) *(4,50,000/-) | Rs. 12,98,077/- |
The above change will hit the Financial Statements of Companies where major work is assigned to Fixed Term Employees. According to provisions of Payment of Gratuity Act 1972 (a), companies were liable to pay the gratuity to irrespective to employment type after 5 years of Service but under the new provisions of Chapter V of Social Security Code 2020, companies will be liable to pay gratuity immediately to Fixed Term Employees after termination of Contract period. Financial Statements of IT, Engineering, Real Estate and Highway Toll Collection companies will be affected by this change.
Point IV – On happening of any such event as may be notified by the Central Government,
This change may affect the following: –
1. Change in Benefit Formulae for Payment of Gratuity
2. Change in Ceiling Limit of 20 Lacs
3. Change in Vesting Condition for Regular Employees
4. Further Change in the Definition of Wages for Regular Employees
5. Changes about the calculation of Past Service
If any of the above change is notified by the Central Government, it will increase the liability of Gratuity in the Financial Statements of the Companies.
Compulsory Gratuity Insurance – Point V
This change will reduce the risk of default on payment of Gratuity to employee by the Companies. As Compulsory Gratuity Insurance will though an Approved Gratuity Trust will arrange the money for payment of gratuity to employees even in case of bankruptcy of the company. Under the provisions of this change each company with more than 10 employees has to secure the Gratuity Payment though a Compulsory Gratuity Insurance. For more details in the matter, you may contact us.
How companies can mitigate the effect of above changes?
Companies generally have 2 options for management of Gratuity Liability and these 2 are as under: –
1.Accounting Option – It is a compulsory option for Companies as it is enforced by the provisions of Section 129 & 133 of Companies Act 2013. In this option companies make provision of gratuity based on an Actuarial Report duly certified by Actuary for compliance of AS 15 Revised 2005/IndAS 19.
2. Funding Option – It is a Discretionary Option for Indian Companies but it is a preferred option due to Annual Tax benefits available under Section 36 (1) (v) of the Income Tax Act 1961. This benefit is not available in option 1 above.
As mentioned in Point IV above that the Gratuity Liability in future will be affected by various factors such as increase wages, increase in services period of employees, so funding option will be the most appropriate method for mitigating the financial impact of such changes in future. To understand this feature of Funding Option, let us take an example of Contributions by the companies and interest accrued in Gratuity Fund.
An employee Roy joins the Company A at Age 35 and the retirement age of the employees in the company A is 60 years. At the time of joining the company on 01.04.2020, his basic salary was 26000/- and there is 5% increase every year in his basic Salary.
Now Gratuity Payable to Roy at his Retirement will be
Total Service Period till retirement –> 60 – 35 = 25 years
Basic Salary at the time of Retirement -> 26000*(1.05) ^25 = 26000*(3.386355) = 88045/-
Now Gratuity Payable as per Payment of Gratuity Act 1972 (a) Formulae to Mr. Roy will be :-
- (15/26) *25*88045 = 1269880/-
Under the Funding Option where company start paying annual contributions into the Group Gratuity Scheme of Insurer and earning only 6% of Interest on the all contributions (which is 8.33% of annual wages of employee) made by the company till retirement will get deductions for contributions and also tax free interest which will reduce the financial burden of any change in the act or code on the shoulders of the company.
A calculation of Tax Benefits and Accumulated Interest is given below for Mr. Roy.
| Age of Mr. Roy | Years | Date of Contri bution | Wages at the time of contr bution | Annual Wages at the time of contrib ution | Contri buted amount by company (8.33% of Annual Wages) | Outst anding Years (OS) | 1.06^ OS | TotaL Interest Accrued on Contr ibuted Amount (@6%) |
| 35 | 0 | 01.04.2020 | 26000 | 312000 | 0 | 25 | 4.292 | 0 |
| 36 | 1 | 01.04.2021 | 27300 | 327600 | 27289 | 24 | 4.049 | 83203 |
| 37 | 2 | 01.04.2022 | 28665 | 343980 | 28654 | 23 | 3.820 | 80796 |
| 38 | 3 | 01.04.2023 | 30098 | 361179 | 30086 | 22 | 3.604 | 78331 |
| 39 | 4 | 01.04.2024 | 31603 | 379238 | 31591 | 21 | 3.400 | 75803 |
| 40 | 5 | 01.04.2025 | 33183 | 398200 | 33170 | 20 | 3.207 | 73211 |
| 41 | 6 | 01.04.2026 | 34842 | 418110 | 34829 | 19 | 3.026 | 70549 |
| 42 | 7 | 01.04.2027 | 36585 | 439015 | 36570 | 18 | 2.854 | 67813 |
| 43 | 8 | 01.04.2028 | 38414 | 460966 | 38398 | 17 | 2.693 | 65000 |
| 44 | 9 | 01.04.2029 | 40335 | 484014 | 40318 | 16 | 2.540 | 62105 |
| 45 | 10 | 01.04.2030 | 42351 | 508215 | 42334 | 15 | 2.397 | 59122 |
| 46 | 11 | 01.04.2031 | 44469 | 533626 | 44451 | 14 | 2.261 | 56048 |
| 47 | 12 | 01.04.2032 | 46692 | 560307 | 46674 | 13 | 2.133 | 52878 |
| 48 | 13 | 01.04.2033 | 49027 | 588323 | 49007 | 12 | 2.012 | 49605 |
| 49 | 14 | 01.04.2034 | 51478 | 617739 | 51458 | 11 | 1.898 | 46224 |
| 50 | 15 | 01.04.2035 | 54052 | 648626 | 54031 | 10 | 1.791 | 42730 |
| 51 | 16 | 01.04.2036 | 56755 | 681057 | 56732 | 9 | 1.689 | 39116 |
| 52 | 17 | 01.04.2037 | 59592 | 715110 | 59569 | 8 | 1.594 | 35375 |
| 53 | 18 | 01.04.2038 | 62572 | 750865 | 62547 | 7 | 1.504 | 31501 |
| 54 | 19 | 01.04.2039 | 65701 | 788408 | 65674 | 6 | 1.419 | 27486 |
| 55 | 20 | 01.04.2040 | 68986 | 827829 | 68958 | 5 | 1.338 | 23323 |
| 56 | 21 | 01.04.2041 | 72435 | 869220 | 72406 | 4 | 1.262 | 19005 |
| 57 | 22 | 01.04.2042 | 76057 | 912681 | 76026 | 3 | 1.191 | 14522 |
| 58 | 23 | 01.04.2043 | 79860 | 958315 | 79828 | 2 | 1.124 | 9867 |
| 59 | 24 | 01.04.2044 | 83853 | 1006231 | 83819 | 1 | 1.060 | 5029 |
| 1240905 | 14890855 | 1214419 | 1168641 |
Now Companies liability to pay Gratuity at the time of retirement is Rs. 12,69,880/-
Deductions claimed by company for contributions were Rs. 12,14,419/-
Tax Free Interest Accrued @6% as given by Insurance Companies will be Rs. 11,68,641/-
Now Additional Surplus available in Gratuity Trust for making payment to other employees will be = 11,13,180/-
The above example clearly shows that Funding Options is the most appropiate method for companies to mitigate the effect of future changes in Gratuity Liability due to changes in Act/Law/Code.
In case you need any clarification regarding Accounting and Funding Option, you may contact us at 9211637063 or email us your requirements at tikaramchaudhary@gmail.com or at tikaramchaudhary@gratuitytrustfund.com .
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