Tax Benefits to Companies under Pay as you Go and Gratuity Trust Formation Option for Payment of Gratuity

This article is an attempt to create awareness amongst Indian and Multinational companies about the tax benefits available to Indian and Multinational Companies under Pay as you Go and Gratuity Trust Formation Option for Payment of Gratuity.

Gratuity benefits are governed by “The Payment of Gratuity Act 1972” and paid by the Company to an employee in addition to his salary on exit from the company. 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

Provided 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: Gratuity is a statutory right of employee whoever completes 5 years in the same organization and is a terminal. It means,

Tax Benefits to Companies under Pay as you Go and Gratuity Trust Formation Option for Payment of Gratuity

Gratuity amount is determined only on the monthly terminal wages of the employee on his exit from the Company after the completion of 5 years of Service. The cost is to be borne by the Company and not by an employee. hence, unlike other fringe benefits (i.e. Medical Insurance, Term Insurance & Accidental Insurance) it can not be part of CTC.

To understand this, let us take an Example, Mr. A Joins the Organization with a Basic Pay of Rs. 26,000/- per month and monthly CTC of 50,000/-. Assuming that expected increase in basic salary is assumed to be 10% p.a. Now Gratuity Payments for next 5 years will be :-

On Completion of 1 Yr – (15/26)* 28,600*1 = 16,500/-

On Completion of 2 Yrs – (15/26)*31,460*2 = 36,300/-

On Completion of 3 Yrs – (15/26)*34,606*3 = 59,895/-

On Completion of 4 Yrs – (15/26)*38,067*4 = 87,847/-

On Completion of 5 Yrs – (15/26)*41,873*5 = 1,20,788/-

Now for making the payment of gratuity, Company has 2 options :

(i) Pay as you go option – Where company makes a provision of Gratuity in the Balance Sheet on the accrual basis taking an actuarial report on BS date from an Actuary. As and when Mr. A leaves the organization, company pay gratuity from their resources and get the tax benefit for the gratuity paid.

Expected Tax Benefit calculation in case of “Pay as you Go Option” :-

For Provision of 1st Yr – NIL

For Provision of 2nd Yr – NIL

For Provision of 3rd Yr – NIL

For Provision of 4th Yr – NIL

For Payment on 5th Yr – 1,20,788/- In this case company, Mr. A will leave the company then company will get the tax benefit of Rs. 1,20,788/-.

(ii) Funding Option – In this option, Company decides to Setup an Approved Gratuity Trust . The Investment of Company is either “Self Managed ” or “ Managed by Insurance Company”. Company contribute the annual contribution in this Gratuity Trust and get the Tax Benefits. In this case, when Mr. A will leave the company, gratuity will be to Mr. A from the Gratuity Trust.

Expected Tax Benefit calculation in case of “Funding Option” under Section 36(1)(v) of the IT Act 1961 for Annual Contribution which is 8.33% of Annual Basic Salary of Employee.

For Contribution of 1st Yr – 28,600*12*0.833 = 28,589/-

For Contribution of 2nd Yr – 31,460*12*0.833 = 31,447/-

For Contribution of 3rd Yr – 34,606*12*0.833 = 34,592/-

For Contribution of 4th Yr – 38,067*12*0.833 = 38,051/-

For Contribution of 5th Yr – 38,067*12*0.833 = 41,857/-

In this case, Mr. A will get gratuity of Rs. 1,20,788/- from the Gratuity Trust and employer will get approximate Tax Benefits of Rs.1,74,536/- for annual contribution made by him in previous 5 years.

To get more clarity on the above example, let us take some more questions about the possibilities/event that may happen on or after completion of 5 years and their impact on the Company in case of “Gratuity Trust Formation Option” :-

Question 1. If employee died during 1st to 4th year before completion of 5th year, then what would be the benefit for Company and employee’s Nominee ?

Answer 1. If employees died after 1 yr, 2nd, 3rd and 4th year but before completion of 5th year, then the company will get tax benefits for the following contributions:-

For Contribution of 1st Yr – 28,600*12*0.833 = 28,589/-

For Contribution of 2nd Yr – 31,460*12*0.833 = 31,447/-

For Contribution of 3rd Yr – 34,606*12*0.833 = 34,592/-

For Contribution of 4th Yr – 38,067*12*0.833 = 38,051/-

The company will get the Tax for the contribution made by him before the date of death of the employee as stated above and employee’s nominee will get following Gratuity Payments from the Trust along with a future service gratuity subject to certain limits as defined by the Insurance Company whilst taking Group Gratuity Scheme from the Insurance Company.

Question 2. If the employee resigns during 1st to 4th year and before completion of 5th year, then what would be the benefit for Company and employee?

Answer 2. If employees resign during 1st to 4th year and before completion of 5th year, then the company will get tax benefits for the following contributions:-

For Contribution of 1st Yr – 28,600*12*0.833 = 28,589/-

For Contribution of 2nd Yr – 31,460*12*0.833 = 31,447/-

For Contribution of 3rd Yr – 34,606*12*0.833 = 34,592/-

For Contribution of 4th Yr – 38,067*12*0.833 = 38,051/-

For Contribution of 5th Yr – 38,067*12*0.833 = 41,857/-

and the employee will not get following Gratuity Payment from the Trust. The amount contributed by the company and interest accrued will be used by the trust for future payments of Gratuity to other employees of the company.

Question 3. If the employee resigns/retires after completion of 5th year, then what would be the benefit for Company and employee?

Answer 3. If employees resigns/retires during after completion of 5th year, then the company will get tax benefits for the following contributions:-

For Contribution of 1st Yr – 28,600*12*0.833 = 28,589/-

For Contribution of 2nd Yr – 31,460*12*0.833 = 31,447/-

For Contribution of 3rd Yr – 34,606*12*0.833 = 34,592/-

For Contribution of 4th Yr – 38,067*12*0.833 = 38,051/-

For Contribution of 5th Yr – 38,067*12*0.833 = 41,857/-

Total Contribution in 5 years………………………= Rs.1,74,536/-

and the employee will get Rs. 1,20,788/- as Gratuity Payment from the Trust. Since the company has contributed an amount in the trust is more then what is payable after 5th year so the surplus amount and interest accrued on the contributions of will be used by the trust for payment to the other employees.

From above examples of “Pay as you go Option” and “Gratuity Trust Formation” it is clear that Gratuity Trust Formation is an beneficial option for Indian Companies covered under the Payment of Gratuity Act 1972 (a).

In case further clarification or requirement you may call me at 9211637063 or email your query at tikaramchaudhary@gmail.com, tikaramchaudhary@gratuitytrustfund.com

Tags: Payment of Gratuity Act 1972

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Author Bio

Name: Tika Ram Chaudhary

Qualification: Other

Company: Our Company is a Corporate Consulting Firm - GTFC. In last 14 years we have provided our Consultation for Actuarial Valuations under 1. Pension, 2. Gratuity, 3. Leave Encashment, 4. PRMB & 5. Long Term Employee Benefit Plans in compliance of AS 15 (Revised 2005), IAS 19 (Revised 2005)-IFRS, USGAAP & NAS 19 (NFRS) We are also providing Consultation for Formation of Income Tax Approved Gratuity Trusts to more than 1000 Indian and Multinational Companies.

Location: New Delhi, Delhi, India

Member Since: 13 Sep 2019 | Total Posts: 24

I am Founder of Corporate Consulting Firm - GTFC. In last 14 years we have provided our Consultation for Actuarial Valuations under 1. Pension, 2. Gratuity, 3. Leave Encashment, 4. PRMB & 5. Long Term Employee Benefit Plans in compliance of AS 15 (Revised 2005), IAS 19 (Revised View Full Profile