Actuarial Valuation Ind AS-19 - Gratuity and Leave Valuation

Thursday, March 14, 2024

Why Companies can not take Gratuity Insurance directly from Insurance Companies without an Approved Gratuity Fund established under Irrevocable System ?

The Payment of Gratuity Act, 1972 is applicable to all establishments (i.e. MNC's, Private Schools, Private Colleges, Private Universities, NGO's, Autonomous Bodies and Other business entities) having more than 10 employees. Gratuity is a statutory right of employee whoever completes 5 years in the same Establishment and is a terminal benefit, it means gratuity amount will be determined when the monthly terminal wages of the employee are known to Establishment. The cost is to be borne by the Employer and not by the Employee hence it can neither be shown as deduction from employees salary nor as a Part of CTC of employee.

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,

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

Tuesday, December 28, 2021

Social Security Code and Benefits of Forming Gratuity Trust in Terms of Part C of Schedule IV

This Post is prepared to create awareness amongst the CA, CS, CMA, CFO, Auditors and Directors of the company about the Impact of Social Security Code on Financial Statements (i.e. Balance Sheet & Profit/Loss Statement) of Indian Companies and Options available to companies for mitigating the such Financial Impact.

The New Provisions for Gratuity Benefits as per Social Security Code 2020 will be effective in near future. Analysis of New Provisions for Gratuity Benefits reveals that there will be an exponential rise in Gratuity Liability of Companies in due to following 4 Provisions: -

i. Change in Definition of Wages (i.e. Wages to be 50% of CTC)

ii. NIL vesting period for Gratuity Payment for Fixed Term Employees.

iii. Vesting period to be 3 years in case of Special Correspondent.

iv. Compulsory Gratuity Insurance for Employees

A detail working for the Analysis of Impact of above 3 factors is available at my recently published article on www.taxguru.in at following weblink - https://taxguru.in/income-tax/factors-affecting-gratuity-benefits-accounting-taxation-gratuity-benefits.html

Companies have 2 options for Management for payment of Gratuity to Employees:

I. Accounting Option – It is compulsory for all Indian Companies, which falls under the preview of Payment of Gratuity Act 1972 (a) till 31.03.2021 & under the preview of Social Security Code, 2020 on or after 01.04.2021. This option is also called Pay as you Go option. All Indian Public Sector, Private Sector and Multinational Companies need to prepare the Financial Statement such as Balance Sheet & Profit/Loss Accounts at the closure of each financial year as per provisions of Section 129 of the Companies Act 2013. As per provisions of Section 133 of the Companies Act 2013, Financial Statements should be prepared in compliance with Accounting Standards as stipulated by the Ministry of Corporate Affairs so that they can give a true and fair view of the state of affairs of the company. Gratuity provision based on the Actuarial Valuation Report received from Actuary is required by the company for compliance of Para 133 of the Companies Act 2013 for preparation of Financial Statement to comply with the requirement of Accounting Standard 15 (Revised 2005) but it is not allowed as a deduction under Section 40A(7) of Income Tax Act, 1961 (as amended time to time). The Section is produced below:-

“ (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.”

II. Compulsory Gratuity Insurance Option – Indian Companies prefer this option due to Annual Tax benefits available under Section 36 (1) (v) of the Income Tax Act 1961. This Tax benefit is not available in option 1 above. Few Benefits of Compulsory Gratuity Insurance are given below: -

1. Tax Benefits

I. Initial Contribution based on actuarial report (Refer Circular : No. 30(XLVII-18), dated 30-11-1964 for clarification for Rule 103 for Initial Contribution of Income Tax Rules 1962) made by the Companies is treated as an

annual expense for Income Tax Computation of the Company (Refer Section 36(1)(v) of Income Tax Act 1961. Section 36(1)(v) of Income Tax Act, 1961 reads as under :-

“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”

II. Annual Contribution an amount equal to 8.33% of basic salaries can be paid into a gratuity fund as a tax-deductible expense.

III. Interest or investment income earned within the gratuity fund is also tax-free.

2. For Risk Management of Gratuity Benefits of Employees even in case of Financial Crisis:- Once companies forms an Approved Gratuity Trust and starts making contribution into the trust then their vulnerability to making the default for Gratuity Payment to employees as per the Section 7 of the Payment of Gratuity Act 1972 is taken over by the Irrevocable trust subject to fund available with them. Since the Approved Gratuity Trust are Irrevocable, so the money contributed by the companies will be exclusively used for payment of Gratuity Benefits to the Employees and fund money cannot be used by the company even in case of Bankruptcy.

3. Liquidity Management: - If Gratuity Benefits are unfunded, companies will need to pay off the gratuities to leaving employees as and when they leave. Therefore, the amount companies would pay Could vary greatly from year to year as the number of people leaving will be uncertain. This would be a particular concern for small or mid-size companies where the resignation of just a few senior employees, with high salary and service, could create a strain on their cashflow positions. On the other hand, if a scheme is ‘scientifically’ (or actuarially) funded, the fund will build up during the years when no major payouts are paid and then used when large payoffs are required to be paid.

4. Cashflow Stability: - For new companies, the gratuity payments to employees would be few and low. However, gratuity payouts increase nearly exponentially as employees age and work longer. By having the liabilities funded, companies can replace the rapidly increasingly gratuity payouts with a relatively stable stream of contributions into the fund.

Companies can avail above benefits after FORMING A CIT APPROVED GRATUITY FUND. As per Governing Rules 98-111 of Income Tax Rules, 1962 for Approved Gratuity Fund - A Gratuity Fund can only be established under an Irrevocable Trust. Establishment of Gratuity Trust requires in-depth knowledge of various rules/regulations and expertise of the following: -

1. The payment of Gratuity Act, 1972 (a)

2. The Companies Act, 2013

3. The Accounting Standards – AS 15 (Revised 2005) & IndAS 19

4. The Indian Trusts Act -1882

5. The Income Tax Act, 1961

6. The Income Tax Rules, 1962

7. The Actuaries Act, 2006

8. The Actuarial Practice Standard – APS 27

9. The Social Security Code &

10. The Minimum Wages Act, 1948, etc.

We as a Team of Experienced Professionals at Gratuity Trust Fund Consultant have over 12 years of experience in helping and providing Actuarial, Legal, Investment and Accounting Solutions for Formation of New Gratuity Trust/Fund as per provisions of the Part C of Fourth Schedule of Income Tax Act 1961 to Indian Public Sector, Private Sector and Multinational Companies. The details of Actuarial, Legal, Investment and Accounting Solutions offered by us are as under: -

1. Actuarial Solutions: The process of Formation of Trust to establish Gratuity Fund starts with Actuarial Valuation of Gratuity Liability for Initial Contribution and it helps Management of a company to understand how much money initially be required to be contributed into the Gratuity Fund of a Trust. Our team give assistance/guidance to the HR, Accounts and Taxation Professional of our clients: -

a. Identification of the Employees to be included for Actuarial Valuation for Initial Contribution & Annual Audit of Gratuity Trust in Compliance of AS 15 (Revised 2005) & IndAS 19 (Refer Section 133 of Companies Act 2013),

b. Guidance for wages to be used for Actuarial Valuations,

c. Guidance for Date Format to be used in Employee Data Preparation,

d. Selection of Gratuity Plan Provision and benefit formulae to be submitted for Actuarial Valuation,

e. Guidance for Analysis of Past Trend of Financial & Demographic Assumptions such as Salary Escalation, withdrawal Rate, Mortality Rate, Disability Rate etc. to be supplied for Actuarial Valuations,

f. Reconciliation of benefit paid & Fund Position to be submitted for Actuarial Valuations disclosures in BS.

g. Support to officials of the company for clarification of Auditors queries related to Actuarial Valuations.

2. Legal Drafting Solutions:

a. Vetting of Board Resolutions, Trust Deed & Trust Rules

b. Vetting of Deed of Variations and Applications required by Trustees/Companies for Approvals from CIT for Gratuity Trust in terms of Part C of Schedule IV of Income Tax Act,1961 in following cases: -

i. Change in Name of Trust,

ii. Change in Address of Trust,

iii. Change in Trustees,

iv. Change in Investment Pattern of Gratuity Funds from Insurer to another,

v. Change in Benefit Formulae for Gratuity Benefits

vi. Change in Retirement Age of Employees

vii. Change in Object of Trust

viii. Change in Trust Rules

ix. Approvals for winding up of Trust due to winding up of the Company

x. Approvals for Transfer of Fund in Event of Merger or De-merger

c. Vetting of Application to CIT for Approval of Gratuity Fund as per guidelines of Rule Number 109 of Income Tax Rules, 1962

d. Vetting of Appeal to CIT for knowing the reasons for status of Approval of Gratuity Fund as per guidelines of Rule Number 111 of Income Tax Rules, 1962

3. Investment Solutions:

a. Advisory to Client for Selection of Gratuity Trust Money Investment as per Rule 67 (2) of Income Tax Rules, 1962 or with Insurer

b. Selection of Insurer based on Rate of Return on Gratuity Fund Investment and annual recurring expenses for Employees Compulsory Gratuity Insurance & Fund Management.

c. Managing communication with Insurer for Claims, Contributions, Annual Fund Statements, change in retirement age, change in trustees etc.

4. Accounting Solutions: We also give Annual Accounting related services for Audit of Gratuity Trust (If applicable).

Our experience in this field is spread over 12 years and we have a vast clientele in all sectors of the Indian Economy such as Industries (Software/Hardware Technology) in the Public and Private Sectors, Universities, Educational Institutes, Schools, Engineering Companies, Pharmaceuticals, FMCG (Fast Moving Consumer Goods) Companies, Warehouses, Laboratories, Hospitals, Hospitalities, Hotels, Banks, etc. etc. Our clients are from outside India also. We have highly skilled office personnel dedicated to rendering top quality service in our field. We’ll be happy to include you in the list of our esteemed clients if you opt to provide an opportunity to serve you. In case of any requirement or clarification in the matter, you may call us at 9211637063 or email your queries/requirements at tikaramchaudhary@gratuitytrustfund.com

Tika Ram Chaudhary

Founder

Gratuity Trust Fund Consultant

An MSME - Registered with Ministry Micro Small and Medium Enterprises vide Registration Number UDYAM-DL-11-0013795

(Corporate Consultant with more than 12 Years of experience in providing Accounting, Investment, Actuarial & Legal Solutions for Formation of Gratuity Trust - Formed by companies to get Tax Benefit available under Section 36 (1) (v) of Income Tax Act 1961 & related Support Services for preparation of Inputs for compliance of AS 15 (Revised 2005), IndAS 19 & IAS 19 (Revised 2011) - IFRS required by Gratuity Trust of Indian Companies)

Registered Office Address: R 11, F/F, R Block, Vikas Nagar, Uttam Nagar, New Delhi -110059

Mobile Number: 9211637063

Landline Number : 011261651

Email Id: tikaramchaudhary@gratuitytrustfund.com

Website : www.gratuitytrustfund.com

LinkedIn Profile: https://www.linkedin.com/in/tika-ram-chaudhary-a5727848/

Caclubindia Profile: https://www.caclubindia.com/profile.asp?member_id=1446582

Tax Guru Profile: https://taxguru.in/author/tikaramchaudhary@gmail.com/

(All services/consultancy is subject to terms and conditions)

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Tuesday, October 19, 2021

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

I hope my below Post may help CA/CMA/CS/AUDITORS OF THE COMPANIES - The financial impact of New Provisions of Social Security Code 2020 to be effective from 01.06.2021 (Date yet to be notified) on Companies Operating in India with employee’s strength 10 or more. In this article we will discuss about the impact of new provisions of Social Security Code 2020 on Gratuity Benefit on Financial Statements of Indian Companies and Benefits of Funding Option to Companies.

Gratuity is a Statutory Liability and it is governed by the Payment of Gratuity Act 1972 (Amended). From 01.06.2021, New provisions of Chapter 5 of Social Security Code, 2020 will be applicable for Gratuity Benefits and it is observed that following changes will cause exponential rise in provisions of gratuity liability in the Financial Statements (i.e Balance Sheet, OCI & Profit/Loss, etc.) of the Companies:

I. Change in Definition of Wages,

II. Change in Vesting Condition for Fixed Term Employees,

III. Change in Vesting Condition for Working Journalists and Other Newspaper Employees,

IV. On happening of any such event as may be notified by the Central Government,

V. Compulsory Gratuity Insurance.

The impact of the above Factors on Gratuity Benefits can be understood by the following Examples:

1. Change in Wages

This change will affect the Financial Statements of the companies, where the Wages are less than 50% of monthly CTC. Let us take an example to understand this change. Say Mr. A is Regular Employee and has completed 5 years of Service with Company ABC and his Wages for computation of Gratuity as on 30.06.2021 is Rs. 2,70,000/- per month which 30% of Monthly CTC Salary (i.e., Rs. 9,00,000/-), Now Gratuity Payable by the company to Mr. A under the provisions of the Payment of Gratuity Act 1972 (a) will be: -

Gratuity Payable on 30.06.2021 = (15/26) *(5) *(2,70,000/-) = Rs. 7,78,846/-

After change in the Definition of Wages under the new provisions of Social Security Code 2020, now new wages of Employee A will be: -

Total Monthly CTC = Rs. 9,00,000/-

New Wages (i.e., 50% of CTC) = Rs. 4,50,000/- (i.e., 9,00,000 * 0.50 = 4,50,000/-)

Now Gratuity Payable to Employee A with new wages as on 01.06.2021 will be: -

Gratuity Payable on 01.06.2021 = (15/26) *(5) *(4,50,000/-) = Rs. 12,98,077/-

Total Impact due to change in Wages will be Rs. 12,98,077/- minus Rs. 7,78,846/- equals to Rs. 5,19,231/-

2. Change in Vesting Condition

This change will affect the Financial Statements of the companies where contractual or fixed term employees are hired for a task such IT & Engineering Companies. Let us take another example to understand how change in vesting condition will affect the Financial Statements of IT, Engineering & Companies where mostly Fixed Term Employees are employed. Let’s Say Mr. A is Fixed Term Employee and working in company from last 5 years with Company ABC and his Wages for computation of Gratuity for last 5 years is Rs. 2,70,000/- per month which 30% of Monthly CTC Salary (i.e., Rs. 9,00,000/-).

Now Gratuity Payable by the company to Mr. A when he resigns the company before 5 years under the provisions of the Payment of Gratuity Act 1972 (a) will be: -

if Employee A leaves the company after completing year 1 = (15/26) *(1) *(2,70,000/-) = NIL

if Employee A leaves the company after completing year 2 = (15/26) *(2) *(2,70,000/-) = NIL

if Employee A leaves the company after completing year 3 = (15/26) *(3) *(2,70,000/-) = NIL

if Employee A leaves the company after completing year 4 = (15/26) *(4) *(2,70,000/-) = NIL

if Employee A leaves the company after completing year 5 = (15/26) *(5) *(2,70,000/-) = Rs. 7,78,846/-

After Implementation of New Provisions of Chapter V of Social Security Code 2020, Gratuity Payable by the company to Mr. A when he resigns the company in 5 years will be:-

if Employee A leaves the company after completing year 1 = (15/26) *(1) *(4,50,000/-) = Rs. 2,59,615/-

if Employee A leaves the company after completing year 2 = (15/26) *(2) *(4,50,000/-) = Rs. 5,19,231/-

if Employee A leaves the company after completing year 3 = (15/26) *(3) *(4,50,000/-) = Rs. 7,78,846/-

if Employee A leaves the company after completing year 4 = (15/26) *(4) *(4,50,000/-) = Rs. 10,38,462/-

if Employee A leaves the company after completing year 5 = (15/26) *(5) *(4,50,000/-) = Rs. 12,98,077/-

The above change will hit the Financial Statements of Companies where major work is assigned to Fixed Term Employees. According to provisions of Payment of Gratuity Act 1972 (a), companies were liable to pay the gratuity to irrespective to employment type after 5 years of Service but under the new provisions of Chapter V of Social Security Code 2020, companies will be liable to pay gratuity immediately to Fixed Term Employees after termination of Contract period. Financial Statements of IT, Engineering, Real Estate and Highway Toll Collection companies will be affected by this change.

3. On happening of any such event as may be notified by the Central Government,

This change may affect the following: -

1. Change in Benefit Formulae for Payment of Gratuity

2. Change in Ceiling Limit of 20 Lacs

3. Change in Vesting Condition for Regular Employees

4. Further Change in the Definition of Wages for Regular Employees

5. Changes about the calculation of Past Service

If any of the above change is notified by the Central Government, it will increase the liability of Gratuity in the Financial Statements of the Companies.

4. Compulsory Gratuity Insurance

This change will reduce the risk of default on payment of Gratuity to employee by the Companies. As Compulsory Gratuity Insurance will though an Approved Gratuity Trust will arrange the money for payment of gratuity to employees even in case of bankruptcy of the company. Under the provisions of this change each company with more than 10 employees has to secure the Gratuity Payment though a Compulsory Gratuity Insurance. For more details in the matter, you may contact us.

How companies can mitigate the effect of above changes?

Companies generally have 2 options for management of Gratuity Liability and these 2 are as under: -

1. Accounting Option - It is a compulsory option for Companies as it is enforced by the provisions of Section 129 & 133 of Companies Act 2013. In this option companies make provision of gratuity based on an Actuarial Report duly certified by Actuary for compliance of AS 15 Revised 2005/IndAS 19.

2. Funding Option - It is a Discretionary Option for Indian Companies but it is a preferred option due to Annual Tax benefits available under Section 36 (1) (v) of the Income Tax Act 1961. This benefit is not available in option 1 above.

As mentioned in Point IV above that the Gratuity Liability in future will be affected by various factors such as increase wages, increase in services period of employees, so funding option will be the most appropriate method for mitigating the financial impact of such changes in future. To understand this feature of Funding Option, let us take an example of Contributions by the companies and interest accrued in Gratuity Fund.

An employee Roy joins the Company A at Age 35 and the retirement age of the employees in the company A is 60 years. At the time of joining the company on 01.04.2020, his basic salary was 26000/- and there is 5% increase every year in his basic Salary.

Now Gratuity Payable to Roy at his Retirement will be

Total Service Period till retirement = 60 Years – 35 Years = 25 years

Basic Salary at the time of Retirement = 26000*(1.05) ^25 = 26000*(3.386355) = 88045/-

Now Gratuity Payable as per Payment of Gratuity Act 1972 (a) Formulae to Mr. Roy will be = (15/26) *25*88045 = 1269880/-

Under the Funding Option where company start paying annual contributions into the Group Gratuity Scheme of Insurer and earning only 6% of Interest on the all contributions (which is 8.33% of annual wages of employee) made by the company till retirement will get deductions for contributions and also tax-free interest which will reduce the financial burden of any change in the act or code on the shoulders of the company.

I hope my below article may help CA/CMA/CS/AUDITORS OF THE COMPANIES - The financial impact of New Provisions of Social Security Code 2020 to be effective from 01.06.2021 (Date yet to be notified) on Companies Operating in India with employee’s strength 10 or more. In this article we will discuss about the impact of new provisions of Social Security Code 2020 on Gratuity Benefit on Financial Statements of Indian Companies and Benefits of Funding Option to Companies.