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Employee Gratuity Trust: Formation and Compliances

Employee Gratuity Trust: Formation and Compliances

Income Tax Act, 1961 offers benefits under Section 36(1)(v) and Section 10(25)(iv) to claim deduction and exemption for gratuity. Section 36(1)(v) allows a deduction to employers for their contribution towards an approved gratuity fund under an irrevocable trust exclusively for the benefit of their employees. Also, under section 10(25)(iv), the act exempts the income received by the trustees on behalf of their approved gratuity fund.

Therefore, for employers, an independent approved gratuity trust can assist them in gratuity related compliances. Here’s a complete guide as to how the gratuity trust can be formed, and what are the related compliances. Read on to understand!

Process for Employee Gratuity Trust Formation

Following is the process for the formation of employee gratuity trust:

  • Initially, gratuity liability shall be assessed on an actuarial basis. This shall be performed by an actuary who shall issue a valuation certificate or actuarial report to determine the contribution to be made by the employer in the Gratuity trust.
  • After the receipt of the actuarial report for the liability accrued, the management of the organization shall approve the same. In the case of a company, a board resolution shall be passed for the creation of the gratuity trust and appointment of at least 2 trustees as required by the Income Tax Rules, 1962. Usually, the legalities and procedures associated with the formation and setting up of the gratuity trust are outsourced by the organization to a Gratuity Fund Consultant through an authorization letter.
  • After the passing of the board resolution and appointment of 2 trustees, the Gratuity Trust Deed and the Trust Rules shall be registered with the Sub-Registrar having jurisdiction where the registered office of the trust is situated. The trust deed should be presented to the Sub-Registrar with the presence of all the trustees along with 2 witnesses.
  • Once the Trust Deed and Trust Rules are registered with the registrar, then the trust can proceed with the application for allotment of PAN and TAN.
  • Once PAN is allotted, the Registered Gratuity trust shall open a bank account with a scheduled bank. After opening the account, the organization shall contribute the amount of the initial contribution through cheque or other banking channels.
  • Upon receipt of the initial contribution, the Gratuity trust can invest the same as per the Income Tax Rules, 1962.
  • After investing the contribution, the organization shall submit an application to the Commissioner of Income Tax of their zone for approval of the Gratuity trust under Part-C of the 4th Schedule of the Income Tax Act, 1961. The application shall be accompanied by the following documents:
    • Board Resolution of the company
    • A copy of the registered trust deed and trust rules
    • PAN and TAN of the trust
    • Bank Account details of the Gratuity trust
    • Investment details of the trust
    • Application to the Commissioner of Income Tax along with other relevant documents.
  • After approval by the Income Tax Department, the Registered Gratuity Trust attains the status of Approved Gratuity trust. The employer can then claim the benefits of the contribution made to the Approved Gratuity trust under Section 36(1)(v) of the Income Tax Act, 1961.

Compliances for the Approved Gratuity Trust

The Approved Gratuity trust shall ensure the following compliances:

1)    Income Tax Compliances: The Approved Gratuity Fund is a separate entity in the eyes of law. Therefore, as per the law, the audit of the Approved Gratuity trust under the Income Tax Act, 1961 shall be conducted each year and Income Tax Return shall be filed.
However, an alternative view on the same is also considered where the sole purpose of the Gratuity Fund is to provide for the employer’s gratuity liability towards its employees and upon this condition, the approval is granted by the Commissioner of Income Tax.

As per Section 139(1), income tax return shall be filed by:

•    company or firm
•    any other person whose income or the income in respect of which he is assessable exceeds the maximum amount not chargeable to tax.

As the income of the Approved Gratuity Fund is wholly exempt under Section 10(25)(iv), its total income does not exceed the maximum amount not chargeable to tax. Hence, the need to file Income Tax Return does not arise.

Further, a list of TDS exempt entities has been notified by the CBDT that enjoys ITR filing exemption and tax exemption in the view that their income is exempt under the Income Tax Act. These entities include:

(xi) Provident fund to which the Provident Funds Act, 1925 (19 of 1925) referred to in sub-clause (i), recognized provident fund referred to in sub-clause (ii), approved superannuation funds referred to in sub-clause (iii), approved gratuity fund referred to in sub-clause (iv) and funds referred to in sub-clause (v) of clause (25);
(xvii) New Pension System Trust referred to in clause (44).

Hence, from the analysis of the above provisions, it can be opined that an Approved Gratuity Trust shall not be liable to file a Return of Income.

2)    Actuarial Report: For complying with the requirements of AS-15 and Ind AS-19, Actuarial Report under the Gratuity Plan shall be availed from the Actuary and an assessment of the annual contribution that shall be made by the company to avail of the deduction under Section 36(1)(v).

Applicability of Certain Income Tax Provisions

Following provisions in the Income Tax Act, 1961 leads to disallowance to the employer in case of a contribution made to the Approved Gratuity Fund:

  • Section 40A(7): This section disallows the deduction for provision made for the gratuity unless it if for contribution to an Approved Gratuity Fund or the provision is for gratuity that has become payable to the employees during the previous year.
  • Section 40(a)(iv): No deduction under Section 36(1)(v) for any contribution made towards any fund established for the benefit of the employees shall be allowed unless the employer has made necessary arrangements for deduction of TDS for the amount of payable from the fund that are chargeable to tax under the head ‘Salaries’.
  • Section 40A(9): The expenses associated with the formation of or setting up of or contribution to any trust, fund, the body of individuals, association of persons, company, or society registered under the Societies Registration Act, 1860 or any other institution except when the sum is paid for the purposes and to the extent as provided under Section 36(1)(iv) / (iva) / (v) or as required by any law for the time being in force.
  • Section 43B(b): This section states that the amount for a contribution towards an Approved Gratuity Fund will be allowed as a deduction under section 36(1)(v) only if it is paid on or before the due date of filing the return.

In case of any assistance for formation and compliances related to your Approved Gratuity trust, feel free to connect with our professionals such as CA, CS, and other Gratuity Trust experts.

Frequently Asked Questions

Q
When shall the gratuity become payable?
A

The gratuity becomes payable when an employee leaves the organization for any of the following reasons:

  • Retirement or superannuation
  • Termination or resignation
  • Disablement or death due to an accident or disease
  • Layoffs or retrenchments
  • Voluntary Retirement Scheme
Q
What is the allowable deduction in respect of the initial contribution to the fund by an employer in respect of the past services of the employee?
A

As per Rule 104 of the Income Tax Rules, the maximum deduction allowable for the initial contribution made by an employer with respect to the past services of the employee admitted to the benefit of the fund shall not exceed 8.33% of the employee’s salary for each year of his past service for the employer.

Q
Whether the rules of the gratuity trust be amended?
A

As per Rule 110 of the Income Tax Rules, any alteration in the constitution, conditions, rules or objects of the gratuity trust shall require prior approval of the Chief Commissioner or the Commissioner.

Q
What is the tax treatment of the contributions and withdrawals from the gratuity trust?
A

The contribution made by the employer is a capital receipt for the trust and therefore shall not be taxable. Further, the income received by the gratuity trust shall be exempt under section 10(25)(iv) of the Income Tax Act, 1961.

Q
Whether contract workers or temporary staffs are eligible to receive a gratuity amount?
A

Contract workers, as well as temporary staffs, are eligible for receiving gratuity amounts till they are considered employees of the organization. However, apprentices are not eligible for receiving a gratuity.

Q
What is the maximum amount of gratuity that shall be paid to an employee?
A

The maximum amount of gratuity that is exempt from tax is Rs. 20 lakhs. This is the maximum tax- exempt gratuity amount that can be paid to the employees.

 

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Nitin

Hi,need assistance in formation of gratuity trust. Do share your proposal on the mentioned email id


Priyanka Panchal

Thanks for sharing details


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