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.
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 31.05.2021 = (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
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.
A calculation of Tax Benefits and Accumulated Interest is given in table below for Mr. Roy.
Age of Mr. Roy | Years | Date of Contribution | Wages at the time of contribution | Annual Wages at the time of contribution | Contributed amount by company (8.33% of Annual Wages) | Outstanding Years (OS) | 1.06^OS | TotaL Interest Accrued on Contributed Amount (@6%) |
35 | 0 | 01.04.2020 | 26000 | 312000 | 0 | 25 | 4.292 | 0 |
36 | 1 | 01.04.2021 | 27300 | 327600 | 27289 | 24 | 4.049 | 83203 |
37 | 2 | 01.04.2022 | 28665 | 343980 | 28654 | 23 | 3.820 | 80796 |
38 | 3 | 01.04.2023 | 30098 | 361179 | 30086 | 22 | 3.604 | 78331 |
39 | 4 | 01.04.2024 | 31603 | 379238 | 31591 | 21 | 3.400 | 75803 |
40 | 5 | 01.04.2025 | 33183 | 398200 | 33170 | 20 | 3.207 | 73211 |
41 | 6 | 01.04.2026 | 34842 | 418110 | 34829 | 19 | 3.026 | 70549 |
42 | 7 | 01.04.2027 | 36585 | 439015 | 36570 | 18 | 2.854 | 67813 |
43 | 8 | 01.04.2028 | 38414 | 460966 | 38398 | 17 | 2.693 | 65000 |
44 | 9 | 01.04.2029 | 40335 | 484014 | 40318 | 16 | 2.540 | 62105 |
45 | 10 | 01.04.2030 | 42351 | 508215 | 42334 | 15 | 2.397 | 59122 |
46 | 11 | 01.04.2031 | 44469 | 533626 | 44451 | 14 | 2.261 | 56048 |
47 | 12 | 01.04.2032 | 46692 | 560307 | 46674 | 13 | 2.133 | 52878 |
48 | 13 | 01.04.2033 | 49027 | 588323 | 49007 | 12 | 2.012 | 49605 |
49 | 14 | 01.04.2034 | 51478 | 617739 | 51458 | 11 | 1.898 | 46224 |
50 | 15 | 01.04.2035 | 54052 | 648626 | 54031 | 10 | 1.791 | 42730 |
51 | 16 | 01.04.2036 | 56755 | 681057 | 56732 | 9 | 1.689 | 39116 |
52 | 17 | 01.04.2037 | 59592 | 715110 | 59569 | 8 | 1.594 | 35375 |
53 | 18 | 01.04.2038 | 62572 | 750865 | 62547 | 7 | 1.504 | 31501 |
54 | 19 | 01.04.2039 | 65701 | 788408 | 65674 | 6 | 1.419 | 27486 |
55 | 20 | 01.04.2040 | 68986 | 827829 | 68958 | 5 | 1.338 | 23323 |
56 | 21 | 01.04.2041 | 72435 | 869220 | 72406 | 4 | 1.262 | 19005 |
57 | 22 | 01.04.2042 | 76057 | 912681 | 76026 | 3 | 1.191 | 14522 |
58 | 23 | 01.04.2043 | 79860 | 958315 | 79828 | 2 | 1.124 | 9867 |
59 | 24 | 01.04.2044 | 83853 | 1006231 | 83819 | 1 | 1.060 | 5029 |
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| 1240905 | 14890855 | 1214419 |
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| 1168641 |
As it understood that companies liable to pay gratuity at the time of retirement to Mr. Roy for Rs. 12,69,880/- but company has already made contributions into Gratuity Trust for Rs. 12,14,419/- and Investment of Contributed Amount into Group Gratuity Scheme of Insurance Company has earned tax free Interest @6% as for Rs. 11,68,641/- Now Additional Gratuity Trust would have surplus for 11,13,180/- (i.e Contribution Plus Accrued Interest Minus Gratuity Paid to Mr. Roy at the time Retirement) available for making payment to other employees will be = 11,13,180/-
The above example clearly shows that Funding Options is the most appropriate method for companies to mitigate the effect of future changes in Gratuity Liability due to changes in Act/Law/Code. Few benefits of Funding Options are given below:-
1. Tax Benefits - Initial Contribution based on actuarial report (Refer Circular : No. 30(XLVII-18), dated 30-11-1 clarification for Rule 103 for Initial Contribution of Income Tax Rules 1962) made by the Companies is treated as a 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”
b. Annual Contribution an amount equal to 8.33% of basic salaries can be paid into a gratuity fund as a tax-deductible expense.
c. 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.
The establishment of Gratuity Trust requires in-depth knowledge of various
rules/regulations and expertise. We have a team-leading Professionals,
Litigation Partners, Chartered Accountants, Company Secretaries & Heads of
Insurance Companies having decades of experience in providing their services to
our clients spread in all sectors of the Indian Economy, in the Public &
Private Sectors which covers areas of Manufacturing, Software, Technology,
Electricity, Electronics, Call Centers, Banks, Educational Institutes, Schools,
Universities, Hotels, Hospitals, Hospitality Companies, etc. etc. Our Firm
“Gratuity Trust Fund Consultant” is engaged in providing Consultancy Services
to Public Sector, Private Sector and Multinational Companies for Formation of
Gratuity Trust/Fund as per provisions of the Part C of Fourth Schedule of Income
Tax Act 1961.
The details of Consultancy Services offered by us are as under: -
1. Formation of a New Approved Irrevocable Gratuity Trust,
2. Investment of Trust Money as per Income Tax Rules 1962,
3. Vetting of Board Resolutions, Trust Deed, Trust Rules & Application for
Approval from CIT,
4. 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: -
a. Change in Name of
Trust,
b. Change in Address
of Trust,
c. Change in
Trustees,
d. Change in
Investment Pattern of Gratuity Funds from 1 Insurer to another,
e. Change in Benefit
Formulae for Gratuity Benefits,
f. Change in
Retirement Age of Employees,
g. Change in Object
of Trust,
h. Change in Trust
Rules,
i. Approvals
for winding up of Trust due to winding up of the Company,
j. Approvals
for Transfer of Fund in Event of Merger or De-merger,
5. Advisory for Process, Advantages & Disadvantages for Formation of
Gratuity Trust,
6. Advisory for Formation/Restructuring of Gratuity Policy as per Social
Security Code, 2020,
7. Consultation about Statutory compliances of The Payment of Gratuity Act,
1972 as per Accounting Standards – 15 (Revised 2005) & IndAS19,
8. Advisory for Accounting & Compulsory Gratuity Insurance Options for
Compliance of The Payment of Gratuity Act, 1972 & *Chapter V-Gratuity of
Social Security Code, 2020 (*Date for Implementation yet to be notified)
Technical/Analytical Support Services : -
We also provide Support Services for preparation of Inputs
for Preparation of Actuarial Valuation Reports/Certificates of Actuary required
by Gratuity Trust of Indian, Multinational & NBFC Companies required in
following events: -
(i). For Initial Funding Assessment of Gratuity and Leave
Encashment Liability by Trustees,
(ii). For assessment of Accrued Liability for Gratuity and Leave
Liability in following events: -
a. Transfer of Employees within a Group
Company.
b. Amalgamation of 2 companies
c. De-merger of
company
d. Winding of Company
(iii). For Annual Audit of Balance Sheets of Gratuity Trust as per
Actuarial valuations Reports/Certificates are also required by Trustees for
compliance of following Accounting Standards: -
a. For Compliance Para 120 (l) of AS 15 (Revised 2005)
b. For Full Compliance Para 120) of AS 15 (Revised 2005)
c. IndAS 19
d. IAS 19 (Revised
2011)
e. US-GAAP
We
have a Team of following Consultants with Decades of Experiences in their field
and present Major Cities of India for execution of the assignments in timelines
stipulated by our client:-
o Legal
Consultants - For Legal Issues involved in Formation of Gratuity Trust
o Taxation Consultants - For Accounting Related Issues
of Gratuity Trust
o Income Tax Consultants - For Documentation of CIT
Approval of Gratuity Trust.
o Investment Consultants - For Gratuity Trust Money
Investment Advisory.
o Actuarial Valuation Consultants - For Actuarial
Valuation Reports/Certificates
o Merchant Bankers – For Assets Value Certification for
Investment of Gratuity Trust
In past 12 years we have provided our Consultancy and Supports
Services to many reputed organizations spread in all sectors of Indian Economy
and the main categories are: -
a. SME Clients
b. Schools/Educational Institutes c. Non - SME Clients
d. Unlisted Companies
e. NBFC
f. Companies Listed in Indian Stock Exchange
g. Companies Listed in Foreign Stock Exchanges
h. Multinational Companies operating in India
To avail our
Consultancy for Formation of Gratuity Trust & Support Services for Preparation
of Inputs for Actuarial Valuations in compliance of AS 15 (Revised 2005), IndAS
19 & IAS 19 (Revised 2011) - IFRS, you may send your requirement
at tikaramchaudhary@gmail.com & tikaramchaudhary@gratuitytrustfund.com
With Regards
Tika Ram Chaudhary
Gratuity, Leave Encashment & Pension Trust Fund Consultant
(Corporate Consultant with more than 12 Years of experience in providing
Support Services to Indian and Multinational Companies for Formation of
Gratuity Trust, formed to gain Tax Benefit available for Companies under
Section 36 (1) (v) of Income Tax Act 1961 & Specialized Support Services
for preparation of Inputs for Actuarial Valuations in compliance of AS 15
(Revised 2005), IndAS 19, IAS 19 (Revised 2011) - IFRS & USGAAP required by
Gratuity Trust of Indian Companies)
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