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Introduction: Gratuity, a crucial component of employee benefits, holds legal and financial significance for both employers and employees. Governed by the Payment of Gratuity Act 1972, its applicability, calculation, exemptions, and tax implications have evolved over time. Recent amendments, such as the Karnataka Compulsory Gratuity Insurance Rules, 2024, further impact its administration. This article delves into the intricacies of gratuity, elucidating its various facets and regulatory updates.

GRATUITY

Applicability of Gratuity:

According to the Payment of Gratuity Act 1972, gratuity applies to employees in various sectors such as factories, mines, oilfields, and more, with 10 or more employees. The Government of Karnataka introduced the Karnataka Compulsory Gratuity Insurance Rules, 2024 on 10 January 2024, mandating employers to obtain insurance under Section 4-A of the Act. Even if employee count falls below 10, gratuity remains applicable, fully funded by the employer.

Registration and compliance requirement under Karnataka Compulsory Gratuity Insurance Rules, 2024:

Registration and compliance requirements stipulated by the rules mandate all employers falling within their scope to promptly submit an application for registering their establishment with the Controlling Authority, namely the Labor Commissioner or their designated officials. This application, to be filed within 30 days of securing insurance, must adhere to the prescribed format (Form I). It should furnish essential details such as the number of insured employees, the name of the insurance company, policy reference numbers, and the terms governing insurance policies, among other particulars.

Additionally, the rules outline the submission of specific forms (Form III) to report any changes, including alterations in insurance policies, employee details, or the number of insured employees. These forms are to be filed with the Controlling Authority or its authorized officials, ensuring transparency and compliance.

Furthermore, employers who have procured valid insurance policies are obliged to fulfill their financial obligations by paying premiums directly to the insurance company. They must also ensure timely renewal of policies, initiating the renewal process before the current policy lapses.

Obligations regarding obtaining an insurance policy as per Rule 3 of Karnataka Compulsory Gratuity Insurance Rules, 2024:

Timeline for registration:

  • New Employers: Within 30 days from the date when these Rules become applicable (no later than 30 January 2024), new employers must secure an insurance policy with correct validity. This policy can be obtained from either the Life Insurance Corporation of India (LIC) or any other insurance company incorporated according to relevant laws.
  • Existing Employers: Within 60 days from the commencement of these Rules (no later than 9 March 2024), existing employers must ensure they have valid insurance coverage.

Payment, reporting responsibilities, and powers of the controlling authority:

  • Employers must ensure timely payment of premiums and regular renewal of the policy.
  • Any changes must be promptly reported to the Controlling Authority within 15 days of policy renewal.
  • In case of disputes, the Controlling Authority, designated under the Payment of Gratuity Act, or other authorized officers appointed by the state government, have the authority to recover gratuity payments from the insurance providers, such as the Life Insurance Corporation of India (LIC), or any other insurance company.

Exemptions:

The Rules provide exemptions for employers in the following cases:

1. Employers who have established an approved Gratuity Fund and intend to maintain such an arrangement.

2. Employers who employ 500 or more individuals and establish an approved Gratuity Fund are exempt from compulsory gratuity insurance. However, to qualify for this exemption:

    • Employers must submit an application in the prescribed form (Form II).
    • The existing approved Gratuity Fund must cover the entire liability of all employees of the establishment.
    • 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.

Eligibility for gratuity under the Gratuity Act requires an employee to have completed at least five full years of service with the current employer, except in cases where an employee passes away or is incapacitated due to accident or illness. In such instances, gratuity must still be provided.

Gratuity is disbursed to an employee upon:

  • Eligibility for superannuation
  • Retirement
  • Resignation
  • Incapacitation due to accident or illness. If an employee passes away, gratuity is paid to the employee’s nominee.

Exemptions on gratuity received: Sec 10(10) of Income Tax Act 1961

For Government Sector Employees:

  • Gratuity provided to employees in the government sector upon their termination, retirement, or superannuation is fully exempt from tax. This exemption applies to employees of the central government, state government, defense sector, members of civil services, and other local authorities.

For Private Sector Employees covered under the Payment of Gratuity Act, 1972:

  • Income tax exemption on gratuity received is calculated based on the least of the following three amounts: a) Gratuity amount of Rs 20 lakhs b) Last 15 days’ salary (calculated using 26 days per month) multiplied by the number of years of employment c) Actual gratuity received

For Private Sector Employees not covered under the Payment of Gratuity Act, 1972:

  • The income tax exemption on gratuity received is determined by the least of the following three amounts: a) Actual gratuity received b) Gratuity of Rs 20 lakhs c) Last 10 months’ average salary multiplied by the number of years of employment, divided by 2

Notes:

  • The calculation of 15 days’ salary is based on the salary last drawn for every completed year of service or part thereof, i.e., 15/26.
  • The number of years in service is rounded off to the nearest full year.
  • Salary is defined as Basic + DA.

Tax Implications for Employers:

Section 36(1)(v) of the Income Tax Act provides a tax deduction for payments made towards an approved gratuity fund established by the employer exclusively for employees, under an irrevocable trust. However, this deduction is subject to Section 43B(b), which allows certain deductions only on a payment basis.

According to these sections, it is evident that a provision for gratuity is not eligible for tax deduction unless it is actually paid out.

Under Section 40A(7), clause (a) states 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) contradicts clause (a) by specifying that clause (a) would not apply if the assessee makes a provision for contribution towards an approved gratuity fund, or for gratuity payments that became payable in the preceding year.

Example:

1. Let’s consider the case of Mr. Y, a 15-year employee of DEF Company. Upon his retirement during the current year, Mr. Y receives his gratuity, despite DEF Company not maintaining a gratuity fund. In this scenario, the gratuity payment is deductible in the current year.

2. In a slightly different scenario, assume a portion of Mr. Y’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 becomes payable within the year.

3. ABC Pvt Ltd, employing 50 workers, has 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 yet on:

Now, the main issue is whether payments to insurers, as per the Notification dated 10 January 2024, where the Government of Karnataka notified the Karnataka Compulsory Gratuity Insurance Rules, 2024, will be eligible for deduction in income tax calculations.

Conclusion:

Understanding the Gratuity Act, its regulations, exemptions, and tax implications is essential for employers to ensure compliance and for employees to comprehend their entitlements. Clear guidelines and adherence to legal provisions benefit both parties involved.

Note: Thank you to my friend CA Koushik for providing valuable insights and information on gratuity.

Author Bio

Experienced CHARTERED ACCOUNTANT with a demonstrated history of working in the accounting industry. Skilled in Analytical Skills, Accounting, Income Tax, Corporate Law, and Tax Deducted at Source (TDS). Strong administrative professional with a chartered accountant focused in Tax Law/Taxation from T View Full Profile

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