“Gratuity” is a terminal retirement benefit payable to employees in the event of retirement, resignation, superannuation, or death, regulated by the Payment of Gratuity Act of 1972. While employers have the option of paying gratuities from their books, many employers set up a ‘Gratuity Fund Trust,’ sometimes utilizing an “Approved Gratuity Fund” to take advantage of a special exemption from taxes allowed by the Income Tax Act of 1961.
This is a comprehensive guide into the setup and taxation aspects associated with the establishment of a Gratuity Fund Trust in India.
What is a Gratuity Fund Trust?
A Gratuity Fund Trust is an irrevocable trust that is established by the employer as a separate trust wherein the employer accumulates the liability of payment of gratuity towards the employees. It is governed by the Income Tax Act of 1961 and holds the contributions only for the purpose of payment of gratuity. On approval, it becomes an Approved Gratuity Fund and is then eligible for the benefits of deduction, exemption, and compliance.
Gratuity falls under Section 4 of the Payment of Gratuity Act, 1972. This specifies the criteria for the payment of gratuity to workers. Exemption for the payment of income tax applies to the gratuity amount paid to workers under Section 10(10) of the Income-tax Act. With regard to tax benefits, the gratuity fund shall be approved based on the criteria provided under Part C of the Schedule IV Income-tax Act provisions. Under the Income-tax Act, the contribution payable to an approved gratuity fund receives a deduction under Section 36(1)(v). Income generated by an approved gratuity trust also receives an exemption under Section 10(25)(iv) of the Income-tax Act.
Why Set Up a Gratuity Fund Trust?
|
Benefit |
Explanation |
|
Tax deduction to employer |
Contribution to Approved Gratuity Fund deductible u/s 36(1)(v) |
|
Tax exemption to employee |
Gratuity received exempt u/s 10(10) (limits apply) |
|
Dedicated investment corpus |
Enables systematic funding of future gratuity liability |
|
Smooth settlement of claims |
Quick disbursement to employees through trust |
Types of Gratuity Funds
- Self-Managed Gratuity Trust Fund
Employer creates an independent gratuity trust and manages the investments internally as per the trust deed and applicable rules.
- Group Gratuity Scheme with LIC / Insurer
Employer establishes a gratuity trust and enters into an arrangement with LIC or another approved insurance provider for professional fund management.
Most organisations prefer the Group Gratuity Scheme due to actuarial valuation, claim management & investment efficiency.
Step-by-Step Process to Set Up a Gratuity Fund Trust
Step 1: Draft a Gratuity Trust Deed
A Trust Deed must contain:
- Name of trust
- Objectives (funding & paying gratuity)
- Trustees appointment & powers
- Rules for contribution, valuation & payment
- Employee eligibility & benefit computation
- Dissolution provisions
The deed is executed on non-judicial stamp paper (value depends on state law).
Step 2: Constitute Board of Trustees
Generally minimum 2–3 trustees are appointed (majority non-interested employee representatives recommended for governance).
Step 3: Obtain PAN & Open Trust Bank Account
- Apply PAN for Trust via Form 49A
- Pass Board Resolution to open a separate trust bank account
Step 4: Conduct Actuarial Valuation
Mandatory for funding estimation and accounting compliance under AS 15 / Ind AS 19
Actuary determines:
- Present & projected gratuity liability
- Contribution amount required
- Funding pattern (annual or lump-sum)
Step 5: Apply for Approval of Gratuity Fund
Application to be made to Income Tax Commissioner (Jurisdictional CIT) under: Rule 109 of Income Tax Rules and Part C – Fourth Schedule
Documents Required
|
Sl. No. |
Required Document |
|
1 |
Trust Deed & Trust Rules |
|
2 |
Board Resolution for creation of trust |
|
3 |
Actuarial valuation report |
|
4 |
Employee list & gratuity history |
|
5 |
Funding plan & investment structure |
|
6 |
PAN & KYC of trustees |
Once approved, the trust gains tax advantages under Section 36(1)(v) & Section 10(25)(iv).
Step 6: Contribution & Fund Management
- Employer contributions routed to trust
- Trust invests as per Rule 67 of Income Tax Rules, 1962
- Claims settled by trust upon employee exit/eligibility
Taxation Framework for Gratuity Fund
Employer perspective
From the employer’s side, contribution made to an Approved Gratuity Fund is allowable as a deduction under Section 36(1)(v) of the Income-tax Act. However, Section 40A(7) restricts deduction of gratuity provisions unless the amount is actually contributed to an approved gratuity fund or trust. Mere book provision without funding is not allowable.
Employee perspective
From the employee’s side, gratuity received at the time of retirement, resignation, death, or termination is exempt under Section 10(10) of the Income-tax Act, subject to the prescribed statutory limits. Further, any amount received from an approved gratuity trust is fully exempt from tax under Section 10(25)(iv).
Compliance & Reporting Requirements
|
Compliance |
Frequency |
|
Actuarial Valuation |
Annual |
|
Contribution to Fund |
As per valuation |
|
Filing returns/ITR for Trust |
Yearly |
|
Investment Declaration & Audit |
Mandatory |
Non-compliance may result in withdrawal of approval and tax exposure.
Conclusion
The establishment of a Gratuity Fund Trust is a tax-efficient and organized way of satisfying the statutory requirements of gratuity provisions. This will allow employers to contribute to gratuity funds on a periodic basis rather than making a single payment at the point of employee exits. This is made possible through periodic actuarial valuation to determine liabilities accurately and through a defined investment strategy to yield tax-friendly returns. After approval by the Income-tax Act, contributions made to the trust by employers will be tax-deductible, and the income from the trust will also remain tax-exempt, thereby optimizing taxes. For the employee, a trust will enable safe and timely remittance of funds for his or her gratuity benefit, thereby enhancing Payment of Gratuity and Income-tax compliance.