Procedure of Approval of Gratuity Funds under Income Tax Act,1961

Section 2(5) of the Income Tax Act, 1961 defines an ‘approved gratuity fund’ as ‘a gratuity fund which has been and continues to be approved by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner in accordance with the rules contained in Part C of the Fourth Schedule’.

In order to get the approval of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner, an application needs to be made under Rule 109, including prescribed particulars regarding the employer, nature of business of the employer, employees eligible to participate in the fund and verified in the prescribed manner.

Application for approval [Rule 109]

The application for approval of a gratuity fund is governed under sub-rule (1) of rule 4 of Part C of the Fourth Schedule of Income Tax Act, 1961.

Text of Rule 119 of Income Tax Rules, 1962

APPLICATION FOR APPROVAL

109.(1) The application for approval of a gratuity fund under sub-rule (1) of rule 4 of Part C of the Fourth Schedule shall contain the following information :—

(a)		Name of employer and address, his business, profession, etc., also his principal place of business.
(b)		Classes and number of employees entitled to admission to the fund—

(i)		in India ;
(ii)		outside India.

(c)		Place where the accounts of the fund are or will be maintained.
(d)		If the fund is already in existence, the details of investment of the fund.

(2) A verification in the following form shall be annexed to the application :—

FORM OF VERIFICATION

We/I, the trustee(s) of the above named fund, do declare that what is stated in the above application is true to the best of our/my information and belief, and that the documents sent herewith are the originals or true copies thereof. 

Text of Rule 4(1) of Part C of the Fourth Schedule of Income Tax Act, 1961

APPLICATION FOR APPROVAL.

4.(l) An application for approval of a gratuity fund shall be made in writing by the trustees of the fund to the Assessing Officer by whom the employer is assessable and shall be accompanied by a copy of the instrument under which the fund is established and by two copies of the rules and, where the fund has been in existence during any year or years prior to the financial year in which the application for approval is made, also two copies of the accounts of the fund relating to such prior year or years (not being more than three years immediately preceding the year in which the said application is made) for which such accounts have been made up, but the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner may require such further information to be supplied as he thinks proper.

Specimen of Application for approval of a gratuity fund

To

The Chief Commissioner/ Principal Commissioner of Income Tax

…………………

Sir

Subject : Gratuity Scheme to be approved under Part “C” of the Fourth Schedule to Income Tax Act, 1961 

We make this application in terms of sub-rule (1) of Rules 4 of Part “C” of the Fourth Schedule to the Income Tax Act, 1961, seeking approval of the Group Gratuity Scheme established under an irrevocable Trust for making provision of Gratuity benefits to the employees of M/s XYZ Ltd.

2. The Deed dated …….. is executed by the Company/Firm and the Trustees appointed for the purpose of administration and the scheme is effective from 01.04.2020. We send herewith a certified copy of the Trust Deed and Two copies of the Rules that regulate the working of the Scheme. The Scheme has been finished in collaboration with Life Insurance Corporation of India.

3. You will observe that the Trust Deed and the Rules have been based on the Standard pattern prepared by the Corporation, provisions of which as we understand, have been approved by you or the Central Board of Revenue for one Scheme of the other. We have also taken care to see that the provision in the main confirm to the limitations laid down by you for a Gratuity Scheme to qualify for approval under Part “C” referred to above and the Income Tax Rules, 1962.

4. The Scheme envisages provision of Gratuity benefits payable to the employees on their retirement from service or in the event of earlier death or leaving service. One special feature of the Scheme is the provision of substantial life cover which when payable on the death of the employee will be larger than that would have been payable as per conventional Gratuity Scheme.

5. The employer meets the entire cost to secure the benefits by making initial contribution and annual contribution in respect of each member over the future years of his service. However, the Rules stipulate that the aggregate of the contribution paid by the employer in respect of any Member shall not exceed 8 1/3 % of the aggregate salary of the Member.

6. As required under rule 109 of Part XIV of the Income Tax Rules, 1962 we give below the following particulars:

(a)	Name of employer and address, his business, profession, etc., also his principal place of business.
(b)	Classes and number of employees entitled to admission to the Scheme		100
	(i)	in India	100
	(ii)	outside India	Nil
(c)	Place where the accounts of the fund are or will be maintained		As given below
(d)	If the fund is already in existence, the details of investment of the Scheme		No

The verification in the form required by you is also appended below:

The Scheme has already commenced and we have paid the annual contribution to the Corporation. We would now request you to examine the Scheme at your earliest and accord your approval there to with effect from 01.04.2020.

Yours faithfully,

Sd/

For SELF & Co. Trustees of

M/s XYZ Ltd.

Employees Group Gratuity Scheme

FORM OF VERIFICATION

We/I, the trustee(s) of the above named fund, do declare that what is stated in the above application is true to the best of our/my information and belief, and that the documents sent herewith are the originals or true copies thereof.

For SELF & Co. Trustees of

Sd/

For M/s XYZ Ltd.

Employees Group Gratuity Scheme

Encl : As above

• Trust Deed
• Rules (2 copies)

The employer company contributing towards gratuity for the employees is required to make such contribution to the irrevocable trust. The said trust required to obtain approval under Part C of Fourth Schedule of Income-tax Act, 1961. The conditions for approval are prescribed under Rule 3 of Part C of Fourth Schedule of Income-tax Act.

Conditions for approval [Rule 3]

3. In order that a gratuity fund may receive and retain approval, it shall satisfy the conditions set out below and any other conditions which the Board may, by rules, prescribe‒

(a) the fund shall be a fund established under an irrevocable trust in connection with a trade or undertaking carried on in India, and not less than ninety per cent of the employees shall be employed in India ;

(b) the fund shall have for its sole purpose the provision of a gratuity to employees in the trade or undertaking on their retirement at or after a specified age or on their becoming incapacitated prior to such retirement or on termination of their employment after a minimum period of service specified in the rules of the fund or to the widows, children or dependants of such employees on their death ;

(c) the employer in the trade or undertaking shall be a contributor to the fund ; and

(d) all benefits granted by the fund shall be payable only in India. 

Documents required for Approval of Gratuity Trust in Terms of Part C of Fourth Schedule of the Income Tax Act, 1961

Once the Investment is done then trustees of the registered Gratuity Trust apply for Approval of Gratuity Trust in Terms of Part C of Fourth Schedule of the Income Tax Act, 1961 with following documents: –

• Board Resolution of Management/Company
• Registered Gratuity Trust Deed and Trust Rules
• PAN and TAN of Trust Deed
• Bank Account
• Details of Gratuity Trust Premium
• Receipt of Investment made by the Trustees into Group Gratuity Scheme of Insurer (LIC, SBI, KOTAK, RELIANCE, HDFC, etc. etc.) or Investment Portfolio of Investment as per rules of Income Tax Rules, 1962.
• Application to Chief Commissioner or Commissioner for Approval and other relevant documents

Once the Approval from the Income Tax Department is received then Registered Gratuity Trust becomes an Approved Gratuity Trust until it continues to satisfies the conditions specified in the Part C of fourth Schedule of Income Tax Act, 1961. 

PART C of fourth Schedule of Income Tax Act, 1961.

Approved gratuity funds

[See section 2 (5), [10(25)(iv)], 17(1)(iii), 36(1)(v)] 

Definitions.

1. In this Part, unless the context otherwise requires, “employer”, “employee”, “contribution” and “salary” have, in relation to gratuity funds, the meanings assigned to those expressions in rule 2 of Part A in relation to provident funds.

Approval and withdrawal of approval.

2. (1) The Commissioner may accord approval to any gratuity fund which, in his opinion complies with the requirements of rule 3 and may at any time withdraw such approval if, in his opinion, the circumstances of the fund cease to warrant the continuance of the approval.

(2) The Commissioner shall communicate in writing to the trustees of the fund the grant of approval with the date on which the approval is to take effeGt, and where the approval is granted subject to conditions, those conditions.

(3) The Commissioner shall communicate in writing to the trustees of the fund any withdrawal of approval with the reasons for such withdrawal and the date on which the withdrawal is to take effect.

(4) The Commissioner shall neither refuse nor withdraw approval to any gratuity fund unless he has given the trustees of that fund a reasonable opportunity of being heard in the matter.

Conditions for approval.

3. In order that a gratuity fund may receive and retain approval, it shall satisfy the conditions set out below and any other conditions which the Board may, by rules, prescribe‒

(a) the fund shall be a fund established under an irrevocable trust in connection with a trade or undertaking carried on in India, and not less than ninety per cent of the employees shall be employed in India ;

(b) the fund shall have for its sole purpose the provision of a gratuity to employees in the trade or undertaking on their retirement at or after a specified age or on their becoming incapacitated prior to such retirement or on termination of their employment after a minimum period of service specified in the rules of the fund or to the widows, children or dependants of such employees on their death ;

(c) the employer in the trade or undertaking shall be a contributor to the fund ; and

(d) all benefits granted by the fund shall be payable only in India.

Application for approval.

4. (1) An application for approval of a gratuity fund shall be made in writing by the trustees of the fund to the Income-tax Officer by whom the employer is assessable and shall be accompanied by a copy of the instrument under which the fund is established and by two copies of the rules and, where the fund has been in existence during any year or years prior to the financial year in which the application for approval is made, also two copies of the accounts of the fund relating to such prior year or years (not being more than three years immediately preceding the year in which the said application is made) for which such accounts have been made up, but the Commissioner may require such further information to be supplied as he thinks proper.

(2) If any alteration in the rules, constitution, objects or conditions of the fund is made at any time after the date of the application for approval, the trustees of the fund shall forthwith communicate such alterations to the Income-tax Officer mentioned in sub-rule (I), and in default of such communication, any approval given shall, unless the Commissioner otherwise orders, be deemed to have been withdrawn from the date on which the alteration took effect.

Gratuity deemed to be salary.

5. Where any gratuity is paid to an employee during his lifetime, the gratuity shall be treated as salary paid to the employee for the purposes of this Act.

Liability of trustees on cessation of approval.

6. If a gratuity fund for any reason cease to be an approved gratuity fund, the trustees of the fund shall nevertheless remain liable to tax on any gratuity paid to any employee.

Contributions by employer, when deemed to be income of employer.

7. Where any contributions by an employer (including the interest thereon, if any) are repaid to the employer, the amount so repaid shall be deemed for the purposes of income-tax to be the income of the employer of the previous year in which they are so repaid.

Appeals.

8. (1) An employer objecting to an order of the Commissioner refusing to accord approval to a gratuity fund or an order withdrawing such approval may appeal, within sixty days of such order, to the Board.

(2) The appeal shall be in such form and shall be verified in such manner and shall be subject to the payment of such fee as may be prescribed.

Particulars to be furnished in respect of gratuity funds.

8A. The trustees of an approved gratuity fund and any employer who contributes to an approved gratuity fund shall when required by notice from the Income-tax Officer, furnish within such period, not being less than twenty-one days from the date of the notice, as may be specified in the notice, such return, statement, particulars or information, as the Income-tax Officer may require.]

Provisions relating to rules.

9. (1) In addition to any power conferred in this Part, the Board may make rules‒

(a) prescribing the statements and other information to be submitted along with an application for approval ;

(b) ‘limiting the ordinary annual and other contributions of an employer to the fund ;

(bb) regulating the investment or deposit of the moneys of an approved gratuity fund :

PROVIDED that no rule made under this clause shall require the investment of more than fifty per cent of the moneys of such fund in Government securities as defined in section 2 of the Public Debt Act, 1944 (18 of 1944) ;

(c)  providing for the assessment by way of penalty of any consideration received by an employee for an assignment of, or the creation of a charge upon, his beneficial interest in an approved gratuity fund ;

(d) providing for the withdrawal of the approval in the case of a fund which ceases to satisfy the requirements of this Part or the rules made thereunder ; and

(e) generally, to carry out the purposes of this Part and to secure such further control over the approval of gratuity funds and the administration of gratuity funds as it may deem requisite.

(2) All rules made under this Part shall be subject to the provisions of section 296.

When Approval for the Gratuity Trust becomes void

Company gets Tax Benefits for Contributions made into an Approved and Registered Gratuity Trust as per Section 36(1)(v) until and unless Approval from the Chief Commissioner or Commissioner is Valid. Approval for the Gratuity Trust becomes void, if Approval is not received from Chief Commissioner or Commissioner in following cases:

• Variation is made in Original Trust Deed.
• Variation is made in Original Trust Rules.
• Appointment of New Trustees.
• Variation in Original Benefits of Gratuity given by the Company in Trust Rules (i.e. Change in Ceiling Limit, Change in Vesting Condition for Gratuity Benefits, Change in Benefit Formula, etc.)
• Changes in Insurer of Group Gratuity Scheme.
• Merger & De-merger of Company
• Winding up of Group Gratuity Scheme

A. the benefit of the fund shall be open to only those persons who are whole-time bona fide employees of the employer, having no substantial shareholding interest;

B. the trust money shall be invested in such trusted securities as are payable both as regards capital and interest in India;

C.the gratuity shall be made payable and shall be paid only in India;

D. the trustees shall be responsible for deduction of tax from the gratuities and crediting the tax so deducted to the Government revenue;

E. the contributions shall be made on a reasonable basis acceptable to the Income-tax Department, i.e., either on actuarial basis or any other basis having regard to the length of service of each employee concerned;

F. so much of the contribution as cannot properly be treated as ordinary annual contributions shall be treated by the Commissioner of Income-tax in the same manner as is adopted by the Central Board of Revenue to deal with similar contributions to an approved superannuation fund.

Rule 4(1) of Part C of the Fourth Schedule to the Income Tax Rules specifically lays down that an application for approval of a gratuity fund shall be accompanied by two copies of the accounts of the fund for the last three years for which such accounts have been made up. This provision contemplates that an application for approval may be made 3 years after the establishment of a gratuity fund. However the board has clarified that, in order that the benefits of approval for the intervening period may not be denied to bona fide gratuity funds, the Commissioners may, after considering all the relevant facts of the case, accord approval to a gratuity fund with effect from the date from which it satisfies the conditions laid down in rule 3 of Part C of the Fourth Schedule. Hence if the fund satisfies the conditions for approval laid down in Rule 3 than such a fund can make an application for approval.

Rule 2(2) of Part C of the Fourth Schedule to the Income-tax Act, provides that the Commissioner shall communicate to the trustees of a gratuity fund the grant of approval with the date on which the approval is to take effect. 

Appeal against the order of Chief Commissioner or Commissioner refusing approval

An employer, objecting to an order of the Chief Commissioner or Commissioner refusing to accord approval to a gratuity fund or an order withdrawing such approval may appeal under sub-rule (1) of rule 8 of Part C of the Fourth Schedule, within sixty days of the receipt of such order, to the Board in Form No. 44 verified in prescribed manner indicated therein and accompanied with a fee of one hundred rupees.

Appeal [Rule 111 of Income Tax Rules, 1962]

111. An appeal under sub-rule (1) of rule 8 of Part C of the Fourth Schedule shall be made in Form No. 44 and shall be verified in the manner indicated therein and shall be accompanied by a fee of rupees one hundred.

Appeals [Rule 8 of Part C of the Fourth Schedule]

8. (1) An employer objecting to an order of the Chief Commissioner or Commissioner refusing to accord approval to a gratuity fund or an order withdrawing such approval may appeal, within sixty days of such order, to the Board.

(2) The appeal shall be in such form and shall be verified in such manner and shall be subject to the payment of such fee as may be prescribed.

FORM NO. 44

[See rule 111]

Appeal against refusal to approve or withdrawal of approval from a gratuity fund

To The Secretary,

Central Board of Direct Taxes,

New Delhi

The petition of ………………………………………, employer(s) carrying on business or profession …………………………… at …………………. Your petitioner(s) applied to (obtained sanction from) the Chief Commissioner or Commissioner of Income-tax under rule 4(1)/[2(1)] of Part C of the Fourth Schedule to the Income-tax Act, 1961, for approval of the gratuity fund maintained by him (them). The Chief Commissioner or Commissioner of Income-tax has refused approval (withdrawn approval) for the reasons stated in his order dated ……. of which a copy is attached.

For the reasons set out below your petitioner(s) submit(s) that the fund should be (continued to be) approved and pray(s) that the Central Board of Direct Taxes may be pleased to direct the Chief Commissioner or Commissioner of Income-tax to accord approval/continue the approval.

GROUNDS OF APPEAL

We/I, , the petitioner(s) named in the above petition, do declare that what is stated therein is true to the best of our/my information and belief.

Date ………..……………….

Signature

 ……………..

Address of the appellant

Notes :

1. Delete the inappropriate words or letters.

2. The appeal should be accompanied by a fee of rupees one hundred. It is suggested that the fee should be credited in a branch of the authorised bank or a branch of the State Bank of India or a branch of the Reserve Bank of India after obtaining a challan from the Assessing Officer and the triplicate challan sent to the Board with the appeal. The Board will not accept cheques, drafts, hundies or other negotiable instruments.

Commissioner has the power to accord approval to Gratuity Fund with retrospective effect from the date from which the Fund satisfied the requirements of rule 3 of Part C of the Fourth Schedule. – Clarification 3 in Circular No. 14 [F.  No. 19/4/69-IT(A-II)], dated 23.04.1969.

Application for approval [Source : Extracts from Minutes (Item 31) of Ninth Meeting of DTAC held on 05.11.1966]  

The suggestion made was that the requirement of rule 4 of Part C of the Fourth Schedule to the Income-tax Act, under which copies of the accounts of the fund for the last three years have to accompany the application for approval, should not apply in the case of newly established gratuity funds.

The Committee was informed that instructions had been issued to the Commissioners to the effect that while according approval to a gratuity fund, they might, after considering all the relevant facts of the case, accord such approval with retrospective effect from the date from which the Fund satisfied the requirements of rule 3 of Part C of the Fourth Schedule.  This would ensure that, even though the fund had to wait for at least three years from its inception before applying for approval in order to satisfy the requirement of rule 4, the approval may, in deserving cases, be accorded from the date of inception of the fund. 

Contributions to the Fund

INITIAL CONTRIBUTIONS

When a new fund has been formed and approved, the employer may make contribution to such fund in respect of the services rendered in the past years by the existing employees. Such contribution however shall not exceed 8 1/3 per cent of the employees’ salary for each year of his past service with the employer.

Annual contributions  

The ordinary annual contribution by the employer to a fund shall be made on a reasonable basis as may be approved by the Chief Commissioner or Commissioner having regard to the length of service of each employee concerned so, however, that such contribution shall not exceed 8 1/3 per cent of the salary of each employee during each year.

Contributions by employer, when deemed to be income of employer

Where any contributions by an employer (including the interest thereon, if any) are repaid to the employer, the amount so repaid shall be deemed for the purposes of income-tax to be the income of the employer of the previous year in which they are so repaid. 

Monies contributed to approved gratuity funds required to be deposited

Text of Rule 101 of Income Tax Rules, 1962

INVESTMENT OF FUND MONEYS.

101. All moneys contributed to the fund after the 31st day of October, 1974 or received or accruing after that date by way of interest or otherwise to the fund may be deposited in a Post Office Savings Bank Account in India or in a current account or in a savings account with any scheduled bank or utilised for the purpose of making contributions under Group Gratuity Scheme entered into with the Life Insurance Corporation of India established under the Life Insurance Corporation Act, 1956 (31 of 1956) or any other insurer as defined in clause (28BB) of section 2 of the Income-tax Act, 1961; and to the extent such moneys as are not so deposited or utilised shall be invested in the manner specified in sub-rule (2) of rule 67, and for this purpose, the expression “investible moneys” in that sub-rule shall mean the moneys of the fund as are not deposited or utilised as aforesaid.

CBDT Circular: No. 482 [F. No. 19/FB/87-TPL], dated 26.03.1987.

Subject :   Contribution received by any approved gratuity fund – Approved modes of depositing – Part C of Fourth Schedule read with rule 101/67 of Income-tax Rules

1. The Government has notified in the Official Gazette dated 09.03.1987, the Income-tax (Second Amendment) Rules, 1987. The said Amendment Rules amend the provisions of rule 101 of the Income-tax Rules, 1962 (‘the Rules’) with effect from April 1, 1987.

2. Under the existing provisions of rule 101 monies contributed to approved gratuity funds are required to be deposited in a Post Office Savings Bank Account or a current account with any sched­ule bank, or are required to be utilised for the purpose of making contributions under Group Gratuity Scheme entered into with the Life Insurance Corporation of India. To the extent such monies are not so deposited or utilised, they are required to be invested in the modes of investment specified in rule 67(2) of the Rules.

3. Under the amended provisions, the contributions received by any approved gratuity fund on or after April 1, 1987, will be required to be deposited in a Post Office Savings Bank Account or in a current account with any scheduled bank or will be required to be utilised for the purpose of making contributions under Group Gratuity Scheme entered into with the Life Insurance Corpo­ration of India.The contributions will not be permitted to be deposited in any of the modes of investment specified in rule 67(2).

Winding up or amalgamation of the fund

Winding up or amalgamation of the fund with another fund shall require the prior approval of the Chief Commissioner or Commissioner.

Winding up of business of employer [Rule 107 of Income Tax Rules, 1962]

At the time of winding up of the business of the employer, the employer shall make satisfactory arrangements for payment of benefits to existing beneficiaries of the fund.

Text of Rule 107

ARRANGEMENTS FOR WINDING UP, etc., OF BUSINESS.

107. Where the employer’s trade or undertaking is to be wound up or discontinued, the trustees shall, with the prior approval of, and subject to such conditions as may be imposed by, the Chief Commissioner or Commissioner, make satisfactory arrangements for the payment of gratuity to the existing beneficiaries.

CBDT Circular No. 595, dated 05.03.1991

Subject : Clarification regarding winding up of superannuation funds

1. The Board had clarified earlier that a gratuity fund, approved under the Income-tax Act, cannot be wound up unless it is neces­sitated by the winding up or discontinuance of the employer’s trade or undertaking, and that the revocation of a gratuity fund cannot be permitted on the basis of a resolution of the trustees and/or beneficiaries.

2. The Board has been requested to consider whether an approved superannuation fund can be allowed to be wound up only when the undertaking of the assessee is wound up or discontinued.

3. Rules 93 and 94 of the Income-tax Rules, relating to superan­nuation funds, are analogous to rules 107 and 108 of the Income-tax Rules relating to gratuity funds. Further rule 3(a) of Part ‘B’ of the Fourth Schedule to the Income-tax Act prescribes that superannuation funds should be established under an irrevocable trust in connection with a trade or undertaking.

4. The Board has, therefore, been advised that an approved super­annuation fund also cannot be wound up unless necessitated by the winding up or discontinuance of the employer’s trade or undertak­ing.

Variation to the rules of the fund [Rule 110 of Income Tax Rules, 1962] 

Rule 110 of the Income tax rules lays down that any amendment to the rules of the fund requires the prior approval of the Chief commissioner or Commissioner.

Text of Rule 110

AMENDMENT OF RULES, etc., OF FUND.

110. No alteration in the rules, constitution, objects or conditions of an approved fund shall be made without the prior approval of the Chief Commissioner or Commissioner.

Income of an approved Gratuity Fund is exempt [Section 10(25)(iv)]

If your gratuity fund registered under section under rule 2(1) part ‘c’ of part ‘C’ Schedule of Income Tax Act, 1961 than any income received on behalf of the approved gratuity fund is exempt from tax.

Text of Section 10(25)(iv)

10(25)(iv) any income received by the trustees on behalf of an approved gratuity fund; 

The funds invested with LIC or other securities mentioned in rule 67(2) fetch returns in the form of dividend, interest, appreciation in NAV etc. This income will again be exempt in the hands of the Trust under section 10(25)(iv).

Income of Gratuity trusts

Generally gratuity trusts receive income from two major sources.

(i) Contribution from Employer

(ii) Interest income from investment of contribution received from Employer

Contribution received from employer should be invested in such manner as prescribed under Income Tax Act. 

Approved Gratuity Fund not liable to file Return of Income

A Gratuity Fund is created with the sole purpose of providing for an employer’s gratuity liability towards its employees. It can have no additional purpose. This is a primary condition which the Commissioner of Income Tax would check before giving approval to the Gratuity Fund [Rule 3(b) of part C of Schedule IV to Income Tax Act, 1961]. As per interpretation of relevant sections and circulars, an Approved Gratuity Fund would not be liable to file Return of Income. Accordingly, Approved Gratuity Fund enjoys unconditional tax exemption and hence not liable to file Return of Income. 

Deduction of contribution made to approved gratuity funds  

Under section 36(1)(v) of the Act, any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the benefit of his employees under an irrevocable trust is allowable as a deduction in the computation of income from business/profession.   However, no allowance shall be made in respect of a payment to a provident or other fund established for the benefit of employees unless the employer has made effective arrangements to secure that tax shall be deducted at source from any payment made from the fund which are taxable under the head “Salaries”.

Text of Section 36(1)(v)

(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust;

Payment on a date after the creation of Trust but prior to date of approval of Gratuity Fund will be allowed as deduction under section 36(1)(v). An approval for a fund which is already set up is in the nature of post facto approval and it relates back to the date on which it is set up in accordance with the scheme of the law – [Prakash Software Solution (P) Ltd. v. Income-tax Officer (2018) 89 taxmann.com 130 (ITAT Ahmedabad)]

Contribution approved gratuity fund – Application by assessee for approval of scheme neither approved nor rejected by competent authority – Entitled to allowance

Dismissing the appeal of revenue the Court held that the assessee could not be made to suffer for the inaction of the authorities and the Assessing Officer ought not to have disallowed the claims of contribution to gratuity scheme merely because the Commissioner had not granted the approval to the gratuity scheme. The assessee was sponsored by the UCO bank, a Government of India undertaking and had duly complied with the conditions laid down for approval under section 36(1)(a) of the Income-tax Act, 1961. Both the appellate authorities had found the expenses allowable based on material and evidence on record. The assessee had fulfilled the condition laid down for approval having created a trust with the Life Insurance Corporation of India and had deposited the amount. The Tribunal was justified in holding that the claims were proper and allowable. No question of law arose. (Related Assessment years :  2007-08, 2008-09, 2009-10) – [CIT v. Jaipur Thar Gramin Bank. (2017) 81 taxmann.com 126 : (2016) 388 ITR 228 (Raj.)] 

Contribution to approved gratuity fund – Actual payment towards gratuity fund was made hence claim was allowable

Assessee had made provision and had also made actual payment towards gratuity fund, hence claim for deduction under section 36(1)(v) is respect of same was allowed. (Related Assessment years : 2009-10, 2010-11) – [CIT v. Shri Siddeshwar Co-operative Bank Ltd. (2016) 240 Taxman 588 (Karn.)] 

Contribution approved gratuity fund – Employees Group Gratuity Fund to LIC – Approval is pending – Eligible deduction

Tribunal held that; where assessee paid amount towards Employees Group Gratuity Fund to LIC and application made by assessee was still pending before Commissioner for approval and assessee had no control over Fund created by LIC for benefit of its employees, disallowance under section 36(1)(v) was not to be made. (Related Assessment year : 2011-12) – [Narasu’s Spinning Mills v. ACIT (2016) 157 ITD 512 (ITAT Chennai)]

Though section 36(1)(v) requires direct payment to the gratuity trust fund, payment to the LIC Group Gratuity Scheme is also allowable

The assessee set up a gratuity fund which was duly approved by the CIT. However, instead of making payment to the fund directly, the assessee paid an amount of Rs. 50 lakhs as initial contribution and an amount of Rs. 5 lakhs as annual premium to the Life Insurance Corporation (“LIC”) pursuant to the group Life Assurance Scheme framed by the LIC for the benefit of the employees of the assessee. The AO disallowed the claim for deduction on the ground that payment towards the gratuity fund was not made to an approved gratuity fund and was not allowable under section 36(1)(v). The CIT(A), Tribunal and High Court [CIT v. Textool Co. Ltd. (2002) 257 ITR 39 (Mad.)] upheld the assessee’s claim on the basis that the payment to LIC under the Group Life Assurance Scheme was for the exclusive benefit of the employees of the assessee under the policy issued by it and that the conditions stipulated in section 36(1)(v) had not been violated. On appeal by the department to the Supreme Court, HELD dismissing the appeal. [CIT v. Textool Co. Ltd. (2002) 257 ITR 39 (2013) 35 taxmann.com 639 (SC)]

ITO cannot question the validity of approval granted to a Gratuity Fund by the Commissioner. If there is an anomaly in the approval granted, only the Commissioner has the power to take corrective steps. All that the ITO can do is examine the conditions precedent to claiming deduction under section 36(1)(v). – [(1993) 71 Taxman 226 (Calcutta)]

Bar on Deduction of contribution made to other than approved gratuity funds [Section 40A(7)] 

Section 40(A)(7) places a bar on deduction of any provision made for payment of gratuity by the employer except where the same is for contribution to approved gratuity fund or if the gratuity is payable in the previous year in which such provision is made.

Text of Section 40A(7)

(7)(a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason. 

(b) Nothing in clause (a) shall apply in relation to any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year.

Explanation. – For the removal of doubts, it is hereby declared that where any provision made by the assessee for the payment of gratuity to his employees on their retirement or termination of their employment for any reason has been allowed as a deduction in computing the income of the assessee for any assessment year, any sum paid out of such provision by way of contribution towards an approved gratuity fund or by way of gratuity to any employee shall not be allowed as a deduction in computing the income of the assessee of the previous year in which the sum is so paid.

Section 40A(7) will apply to those assessee who do not have an approved gratuity fund. An assessee will not get deduction for provision made for gratuity unless it is for contribution to Approved Gratuity Fund or unless the Provision is for Gratuity that has become payable to employees during the year. Therefore, if an assessee creates a mere Provision for Gratuity that is not for contribution towards Approved Gratuity Fund or not for Gratuity that has actually become payable, no deduction will be available irrespective of the fact that Provision has been made on the basis of Actuarial Valuation Report. [CBDT Circular No. 169, dated 23.06.1975]

CBDT Circular No. 169 (para 27), dated 23.06.1975.

Subject : Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its insertion by the Finance Act, 1975, with effect from 01.04.1973

In the Board’s Circular No. 47, dated 21.09.1970 [Clarification 2]. It was stated that provisions made by an assessee in his accounts on a scientific basis in respect of estimated service gratuity payable to employees would be admissible as deduction under section 37(1). The matter was re-examined by the Board in 1974 and the earlier instructions were withdrawn by the Board’s Circular No. 146 dated 26.09.1974 [Clarification 2].  Some of the High Courts have recently taken a view that a provision made by an assessee in his accounts in respect of estimated service gratuity payable to employees will be deductible in computing the taxable income in cases where the provision has been made on a scientific basis in the form of actuarial valuation.  In order to remove uncertainty, in the matter, the Finance Act, 1975 has inserted a new sub-section (7) in section 40A which provides that no deduction will be allowed in the computation of taxable profits in respect of mere “provisions” made by employers in their books of account for payment of gratuity to their employees on their retirement or on termination of their employment for any reason.  The amendment will not, however, affect provisions made for the purpose of payment of sums by way of contribution towards approved gratuity funds that have become payable during the previous year, or for the purpose of making any payment on account of gratuity to employees where such gratuity has become payable during the previous year and such provisions will continue to be eligible for deduction as hitherto. 

Taxability of gratuity in the hands of employees  

As per Section 10(10) of the Income Tax Act, 1961, gratuity received by a government employee is fully exempt from tax. However, for non-government employees the maximum tax-exempt gratuity limit is Rs 20 lakh as of now.