An approved gratuity fund under income tax is a fund that has been approved by the Income Tax Department of India. Once approved, the employer can deduct contributions to the fund from the employee’s salary and the employee will not have to pay income tax on the contributions. The employer can also claim a deduction for the contributions paid to the fund.

To be eligible for approval, the gratuity fund must meet the following conditions:

• It must be established for the benefit of employees.
• It must be irrevocable, meaning that the employer cannot withdraw the contributions.
• The benefits payable from the fund must be based on a formula that is determined in advance.
• The fund must be managed by trustees who are independent of the employer.
• The fund must be registered with the Income Tax Department.

The benefits payable from an approved gratuity fund are taxable in the hands of the employee when they are received. However, the employee can claim a deduction for the contributions that they have made to the fund.

To approve a gratuity fund, the employer must submit an application to the Income Tax Department. The application must be accompanied by a copy of the instrument under which the fund is established and the rules of the fund. The Income Tax Department will then review the application and approve the fund if it meets all of the conditions.

Once the fund is approved, the employer must file a return with the Income Tax Department each year. The return must include information about the contributions made to the fund and the benefits paid out.

Benefits of an approved gratuity fund

There are several benefits to having an approved gratuity fund:

• The employer can deduct contributions to the fund from the employee’s salary and the employee will not have to pay income tax on the contributions.
• The employer can also claim a deduction for the contributions paid to the fund.
• The benefits payable from the fund are taxable in the hands of the employee when they are received, but the employee can claim a deduction for the contributions that they have made to the fund.
• An approved gratuity fund can help to improve employee morale and retention.
• It can also provide employees with a financial safety net in case of retirement, death, or disability.

EXAMPLES

State: Maharashtra

Employer: Tata Consultancy Services Ltd. (TCS)

Gratuity Fund: TCS Maharashtra Gratuity Fund Trust

Approval: Approved by the Principal Commissioner of Income Tax, Pune, on 1 January 2023.

Eligibility: All employees of TCS who are employed in Maharashtra and who have completed at least one year of service are eligible to become members of the gratuity fund.

Contributions: TCS contributes 4.81% of the basic salary of each eligible employee to the gratuity fund. Employees are not required to make any contributions to the fund.

Benefits: Eligible employees are entitled to receive gratuity from the fund upon retirement, resignation, or termination of employment. The amount of gratuity is calculated based on the employee’s last drawn basic salary and the number of years of service.

How to apply for approval of a gratuity fund in a specific state in India:

1. Establish a trust under the Indian Trusts Act, 1882, for the sole purpose of providing gratuity to employees.
2. Frame the rules of the trust in accordance with the requirements of the Income Tax Act, 1961, and the rules made thereunder.
3. Make an application for approval of the gratuity fund to the Principal Commissioner of Income Tax in the state where the employer is headquartered.
4. The application should be accompanied by a copy of the trust deed, the rules of the trust, and other relevant documents.
5. The Principal Commissioner of Income Tax will examine the application and, if satisfied, will grant approval to the gratuity fund.

FAQ QUESTIONS

What is an approved gratuity fund?

A: An approved gratuity fund is a fund created by an employer for the benefit of its employees to provide them with a gratuity on retirement or death. The fund must be approved by the Income Tax Commissioner in accordance with the rules contained in Part C of the Fourth Schedule to the Income Tax Act, 1961.

Q: What are the benefits of having an approved gratuity fund?

A: There are two main benefits of having an approved gratuity fund:

1. Tax benefits for the employer:The employer’s contributions to the fund are allowed as a deduction in the computation of its income tax liability.
2. Tax benefits for the employees:The gratuity received by the employee from the fund is exempt from income tax to the extent of Rs.20 lakhs.

Q: Who is eligible to join an approved gratuity fund?

A: All employees of the employer are eligible to join an approved gratuity fund, unless they are covered by a provident fund or other superannuation scheme.

Q: How is the gratuity calculated?

A: The gratuity payable to an employee is calculated based on the employee’s last drawn salary and the number of years of service with the employer. The formula for calculating gratuity is as follows:

Gratuity = (Last drawn salary * Number of years of service) / 20

Q: When is the gratuity payable?

A: The gratuity is payable to the employee on retirement or death. In case of death, the gratuity is payable to the employee’s nominee.

Q: How to apply for approval of a gratuity fund?

A: The employer must apply for approval of the gratuity fund to the Income Tax Commissioner in the prescribed form. The application must be accompanied by a copy of the trust deed and rules of the fund.

Q: What are the requirements for an approved gratuity fund?

A: An approved gratuity fund must comply with the following requirements:

• The fund must be established under an irrevocable trust.
• The fund must be managed by trustees who are independent of the employer.
• The fund must be used solely for the purpose of providing gratuity to employees.
• The fund must be wound up within 3 years of the closure of the business.

Q: What happens if an approved gratuity fund ceases to be approved?

A: If an approved gratuity fund ceases to be approved, the trustees of the fund will be liable to pay tax on any gratuity paid to any employee.

CASE LAWS

• CIT v. Associated Cement Companies Ltd. (1976) 101 ITR 512 (SC): The Supreme Court held that the initial contribution to an approved gratuity fund is not allowable as a deduction in computing the taxable income of the employer under Section 36(1)(v) of the Income-tax Act, 1961.
• CIT v. TISCO (1978) 113 ITR 180 (SC): The Supreme Court held that the interest earned on the contributions made to an approved gratuity fund is not taxable in the hands of the employer.
• CIT v. HMT Ltd. (1995) 212 ITR 504 (SC): The Supreme Court held that the surplus in an approved gratuity fund is not taxable in the hands of the employer.
• CIT v. Tata Sons Ltd. (2002) 256 ITR 181 (SC): The Supreme Court held that the employer is not entitled to any deduction in respect of the gratuity paid to an employee from the approved gratuity fund.
• CIT v. Infosys Technologies Ltd. (2014) 366 ITR 270 (SC): The Supreme Court held that the employer is entitled to a deduction for the gratuity paid to an employee from the approved gratuity fund, even if the employee has already retired from service.