Unraveling Gratuity Provisions under Income Tax: Sections 40A(7) and 36(1)(v)
Income tax laws encompass a vast array of provisions, two of which relate to the provision for gratuity: Section 40A(7) and Section 36(1)(v). Let’s delve into an exhaustive interpretation of these two legal sections.
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.
The second explanation to this section clarifies that if a provision for gratuity payment to employees was allowed as a tax deduction in any given assessment year, any subsequent contribution towards an approved gratuity fund or gratuity payment to an employee from this provision will not be permitted as a tax deduction in the year of such payment.
Therefore, this section disallows a provision for gratuity unless it is:
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, which permits certain deductions only on a payment basis.
By amalgamating the principles of these two sections, it becomes clear that a provision for gratuity is permissible as a tax deduction on the condition that it’s tied to an approved gratuity fund.
Consider the case of Rajakrishnappa Bairya, a 15-year employee of KGF Industries. Upon his retirement during the current year, Rajakrishnappa receives his gratuity, despite KGF Industries not maintaining a gratuity fund. In this situation, the gratuity payment is deductible in the current year.
In a slightly different scenario, assume a portion of Rajakrishnappa’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.
Finally, consider Pushpa Sandalwood Corp 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 and satisfies the conditions stipulated in Section 43B.
The provisions for gratuity as discussed under Sections 40A(7) and 36(1)(v) of the income tax laws are crucial for understanding how gratuity payments are treated from a tax perspective. Taxpayers and companies need to comprehend these regulations thoroughly to make informed decisions regarding gratuity payments and provisions.