GRATUITY (ALL ABOUT GRATUITY - WHICH YOU MUST WANT TO KNOW)

Gratuity is a lump sum payment made at the time of the exit of any employee, by the employer in gratitude for the services rendered by the employee. The Payment of Gratuity Act, 1972 provides for payment of gratuity to the employees.

The main provisions of the Act in 1972 were as follows:
1. All the establishments in which 10 or more employees are employed are covered under the Act.
2. Employees drawing a salary(Basic+DA) of less than Rs. 1000 per month only were covered under the Act.
3. 15 days salary(Basic+DA) for each year of service was to be paid as gratuity at the time of exit by resignation, death or retirement.
4. In case of resignation a completed service of 5 years was required for the eligibility.
5. A maximum of 20 months salary and a monetary limit of 30000 were fixed as the ceiling.

Gradually the ceiling on salary for eligibility was raised periodically to Rs. 1600, 2500, 3500 and then removed. The ceiling on gratuity was raised periodically to Rs. 36000, 50000, 100000, 250000, 350000 and now stands at Rs.1000000 (with effect from 24.05.2010). The 20 months salary ceiling on gratuity was removed.

15 days salary was construed as salary for half a month and on that basis gratuity was being paid. But some of the unions went to Court claiming that monthly salary pertains to 26 working days, leaving four Sundays. This contention was accepted by the Courts, and on that basis the gratuity was calculated at the rate of 15 days salary and each day’s salary was taken as 1/26th of the monthly salary. This was also incorporated in the Gratuity Act by an amendment.

Thus it is a statutory liability and all the employers (with 10 or more employees) covered under the Act have to make the payments compulsorily.

For a long time most of the employers were paying gratuity on a “Pay as you go method”. That is whenever an employee resigns, retires or dies his gratuity was paid in that year and shown as expenses for that year. No provision or funding was made. But as the liability arises every year, it was felt that each year’s balance sheet should reflect that year’s liability in respect of that year’s gratuity. At the same time, the gratuity actually payable at the time of exit will depend on the time of exit and the salary at the time of exit, which are variables and cannot be determined with precision. Therefore an actuarial valuation, taking into account the probabilities of salary increase, death, resignation and retirement, was made mandatory as per the Accounting Standard-15 (AS-15) issued by the Institute of Chartered Accountants of India.

Different ways of meeting Gratuity Liability:

(i) An employer may set up an internal reserve or provision in the books of accounts based on actuarial valuation of the liability.

(ii) An employer may set up an irrevocable gratuity trust fund which is approved under part ‘C’ of the Fourth Schedule of the Income Tax Act 1961.

(iii) An employer may set up a fund as in (ii) and the trustees may enter into a group gratuity scheme with an insurer.

Creation of Internal Reserve:

After the introduction of Section 40A(7) of the Income Tax Act, it is not possible to obtain income tax relief on the internal reserve created by the mere accounting provision in the books. But companies, which in their initial years of existence and which do not have too much of profits can, adopt this method. Their liability in respect of gratuity will relate to only death gratuity, which will be very small and as employees resigning before completing 5 years of service are not eligible for gratuity.

Funding through Trust:

The employer is required to part with the proprietary control over the funds. The gratuity rights of the employees become independent of the business fortunes. The reserves are setup on the basis of the concept of going concern where most of the employees would retire from service on attaining specific age, but for early death or resignation.

Trustee Administered Fund

If the trustees decide to manage the gratuity funds themselves, then it will be their responsibility to arrange for investment of the contributions according to the pattern prescribed by the rule 101 of the IT Act. The rate of contribution will have to be determined scientifically by an actuarial valuation of the liability and the same has to be reviewed periodically.

Insured Group Gratuity Scheme:

While extending the advantages of immediate income tax relief to the employer and security to the employees, the trustees can enter into a Group Gratuity Scheme with the insurer. It has two fold advantages, relieving the trustees of the responsibilities of investment of contribution and administration of the fund and provision of higher amount of gratuity payable in the event of death of employee while in service.

Comparison of Trustee Administered scheme and Insured Scheme:

The main advantages of an insured fund over a self-managed fund are as follows:

1. Possibility of earning a higher yield. Now that more private life insurers have entered the market, different options are available for the companies to invest their gratuity funds. Many funds are unit linked, and offer a higher return (however not guaranteed) with options like secure fund, growth fund, balanced fund etc. There are also options for switching from one fund to another.

2. Liquidity: Liquidity is better under the insured schemes, as whenever employees retire or resign or die, the gratuity payable can be obtained from the insurer without any loss of interest. But for self managed funds, either they have to keep liquid funds for paying gratuity, which will result in loss of interest or sell securities at a loss to make the payments.

3. Management: The problems of managing and investing the funds are removed from the company. The insurance companies with huge funds have better expertise in investing and hence may be able to get a better yield on the funds.

4. Additional death benefit: An additional death benefit equal to the future service gratuity of an employee who dies in service is provided by a term assurance, for which an extra risk premium has to be paid.