Gratuity Trust and Related Accounting and Compliances

Indian Business has to comply with gratuity regulations. On the top of payment of Gratuity Act, 1972, there are specific regulations enforced at state level in India. Example, certain states mandates creation of gratuity trust or subscribing to recognized gratuity trust fund plan.

Now let us look at various accounting and compliances aspects of the gratuity trust in India.

A. Formation of Gratuity Trust

1. Gratuity trust must be set up as an irrevocable trust
2. Gratuity trust must be set up for providing gratuity benefits to the employees trust to act as a separate legal entity.
3. Employer can appoint trustees for monitoring and administration of the fund
4. The trust must get an approval from under the Income Tax Act, 1961 to be recognized as approved gratuity trust.
5. Trustees can chose to manage the fund as per by laws of the trust. Common practice is to enter into a master policy with the insurance company to provide death-cum-retirement benefits to the employees.
6. All the monies contributed to the fund by the employer or received or accruing by way of interest or otherwise to the fund may be deposited in such separate bank account or utilized for making contribution to the group gratuity scheme under master policy entered into with the insurance company.
7. The amount not so deposited or unutilized money shall be invested in the manners prescribed in rules 67(2) and 101 of the income tax rules, 1962.
8. The gratuity trust shall provide for payment of gratuity on termination of service/employment, on death or retirement of the employee.

B. Ind AS Accounting for Gratuity Trust

Accounting of gratuity trust under Ind AS needs to be analyzed from standalone books of trust and the consolidation aspects along with employer. Let us first look at the Ind AS complexity related to gratuity trust. First questions come to mind is ?if the consolidation of gratuity trust requires to be done along with the employer financials?.

Analysis for Control Assessment and Consolidation

Ind AS 110 lays down the principles for presentation and preparation of consolidated financial statements when an entity controls another entity. It also defines the principles of control and establishes control as the basis for consolidation.

In order to determine control, we have to refer para 5, 6 and 7 of Ind AS 110, which are reproduced as under ?

Para 5 states that ? ?An investor, regardless of the nature of its involvement with an entity (the investee), shall determine whether it is a parent by assessing whether it controls the investee.?

Para 6 states that ??An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.?

Para 7 states that ? ?Thus, an investor controls an investee if and only if the investor has all the following:

1. Power over the investee (see paragraphs 10?14);
2. Exposure, or rights, to variable returns from its involvement with the investee (see paragraphs 15 and 16); and
3. The ability to use its power over the investee to affect the amount of the investor?s returns (see paragraphs 17 and 18)

Normally, the employer meets the conditions of para 7 (a) and (c). Further, the trust may not fit into criteria of para (b).

However, Ind AS has given a specific exemption for certain kind of trust for consolidation.

Paragraph 4(b) of Ind AS 110 states that ?This standard does not applies to post-employment benefit plans and other long-term employment benefit plans to which Ind AS 19 applies.

Since, the trust has been specifically formed to manage the gratuity compliance related to Employer and accordingly, the exemption granted under Ind AS 19 will apply.

Based on above it can be concluded that that there is no requirement to consolidate the trust in the financial statement of the employer.

C. Accounting of Gratuity Trust

In the Books of Employer

Employer will be making the annual contributions to the gratuity trust. At every reporting period, the employer needs to get an actuarial valuation done. Trust doesn?t require a separate gratuity valuation.

For accounting purposes, employer have to pass the below mentioned entries in their books of accounts:

Your actuary will give various information required in the above table for accounting entries.

Accounting In the Books of Gratuity Trust

In the books of trust, the main source of fund is the contributions received from employer. The fund will be applied towards contribution to insurance plan or some other approved investment. At the time of separation or retirement of an eligible employee, the gratuity amount is paid out of the trust fund to the employee.

Accounting entries in the books of the trust will be ?

D. Analysis for Income Tax Treatment

An approved gratuity trust will be treated as a separate legal entity under Income Tax Act. The trust would be assessable as an AOP as per clause (iv) to first proviso to section 164 (1). The trust must fulfills below conditions:

A. Trust must have a separate PAN card.

B. Trust must have a separate bank account with a scheduled bank (Rule 101) or deposit to group gratuity scheme with LIC or invested as per rule 67(2).

C. Separate books of accounts to be maintained ? rule 109(1)(c)

D. The trust must fulfill of conditions of part C of the fourth schedule of Income Tax Act, 1961.

1. It must be an irrevocable trust in connection with a business undertaking of employer in India, and not less than 90% of its employees are employed in India.
2. Employer must establish the trust exclusively for meeting the gratuity liability of its employees.
3. Employer must be a contributor to the fund.
4. All the benefits granted by the fund shall be payable only in India.

Further, as per section 10 (25)(iv) of the Income Tax Act, 1961, income received by the trust shall not be chargeable in the hands of trustee if the trust is an approved gratuity trust.

Tax Treatment in the Hands of the Trust - The contribution received from employer, normally will be treated as capital receipt and hence not liable to tax. If someone has to argue, that it is not a capital receipt but a revenue receipt, in that case the same will also be exempted u/s 10(25)(iv), as discussed above.

Further, any income received by the trust will also be exempt from tax u/s 10(25)(iv).

In the Hands of Employer ? The contribution to the approved gratuity trust will be treated as contribution by an employer to an approved gratuity trust for exclusive benefit of its employees and is an allowable deduction u/s 36(1)(v) of Income Tax Act, 1961.