316. Contribution to approved gratuity fund - Points connected with tax relief in respect of initial contribution under clause (v) of sub-section (1) and approval of gratuity fund

CLARIFICATION 1

Treatment of initial contribution: Certain points have been raised in connection with the provisions in the Income-tax Act, 1961, relating to gratuity funds. These points and Board’s comments thereon are as under :

Point No. 1: Paragraph 6 of Board’s Circular No. 70(XI-3), dated 3-11-1951 (Annex) indicates the manner in which tax relief in respect of initial contribution to a gratuity fund, which has been "informally" approved under the aforesaid circular, should be calculated.  Do these instructions continue to hold good even after the coming into force of the 1961 Act?  If not, how should the initial contribution to approved gratuity funds be treated.

Comments : Section 36(1)(v ) provides that any sum paid by an assessee as contribution towards an approved gratuity fund shall be allowed as a deduction in computing his business income.  Rule 104 of the Income-tax Rules, 1962, provides that the amount to be allowed as a deduction on account of initial contribution shall not exceed 8¹ /₃ per cent of the employee’s salary for each year of his past service with the employer.  The aforesaid rule is effective from April 1, 1962, and is applicable to assessments for the assessment year 1962-63 and subsequent years.  The instructions contained in paragraph 6 of the Board’s Circular referred to hereinabove are, therefore, not applicable to assessments for the assessment year 1962-63 and earlier years.

Point No. 2: Is there any time limit for payment of initial contributions under rule 104 of the Income-tax Rules?

Comments : Rule 104 lays down that any initial contribution in respect of the past services of an employee admitted to the benefits of the fund shall not exceed 8¹ / ₃ per cent of the employee’s salary for each year of his past services with the employer.  The language of the rule implies that the initial contribution has to be made in the year in which the employee is admitted to the benefits of the fund [see Clarification 2] .

Point No. 3 : How should the date of approval of a gratuity fund be reckoned?

Comments : Rule 2(2) of Part C of the Fourth Schedule to the Income-tax Act, provides that the Commissioner shall communicate to the trustees of a gratuity fund the grant of approval with the date on which the approval is to take effect.  Unlike in rule 78, relating to recognised provident funds, there is no provision in the rules relating to approved gratuity funds in regard to the date from which the order of approval in the case of gratuity fund should take effect.  Rule 4(1) of Part C of the Fourth Schedule specifically lays down that an application for approval of a gratuity fund shall be accompanied by two copies of the accounts of the fund for the last three years for which such accounts have been made up.  This provision contemplates that an application for approval may be made 3 years after the establishment of a gratuity fund.  ln order that the benefits of approval for the intervening period may not be denied to bona fide  gratuity funds, the Commissioners may, after considering all the relevant facts of the case, accord approval to a gratuity fund with effect from the date from which it satisfies the conditions laid down in rule 3 of Part C of the Fourth Schedule.

Circular : No. 30(XLVII-18), dated 30-11-1964.

ANNEX - CIRCULAR DATED 3-11-1951 REFERRED TO IN CLARIFICATION

Contribution to gratuity fund constituted into irrevocable trust for the benefit of employees -Allowance thereof under the 1922 Act - 1. It has been brought to the notice of the Board that as a result of the award by industrial courts, textile mills are now compelled to pay their retiring employees gratuities at the following rates:

1. On the death of an employee while in service - One month’s salary for each year of service subject to a maximum of 15 months’ salary to be paid to the deceased employer’s heirs or executors or nominees.

2. On voluntary retirement or resignation of an employee - After 15 years’ continuous service with the employers, 15 months’ salary.

3. On termination of an employee’s service - (a) after continuous service for 10 years but less than 15 years, 3-4 of the one month’s salary for each year of service, (b) after 15 years’ continuous service, 15 months’ salary.

It is also understood that the above award applies not only to future employees but also to the past, present and future service of employees who are already in service.

2. Certain employers are now contemplating the creation of gratuity funds so as to make provision for the gratuities referred to above. Under the present income-tax law no amount set apart by way of reserve for gratuity (or for any other purpose) can be allowed as a deduction in computing the profits for income-tax purposes but the actual payment of gratuity can be allowed as and when paid, provided that the employer makes adequate arrangements for deduction and payment of tax from the gratuities.

3. Unlike the provisions in the Income-tax Act relating to recognition of provident funds or approval of superannuation funds, there is no provision for approving any other type of funds, but section 10(4)( c) provides that no allowance shall be made in respect of a payment to a provident or other fund established for the benefit of employees unless the employer has made effective arrangements to secure that tax shall be deducted at source from any payment made from the fund which are taxable under the head "Salaries".  It would, therefore, appear that the said section contemplates that contributions by employers to funds other than recognised provident funds or approved superannuation funds or provident funds to which the Provident Funds Act of 1925 applies, can be considered as an admissible deduction provided that the essential condition (but not necessarily the only condition) referred to in section 10(4)(c) is satisfied.  The Board consider that if a gratuity fund is constituted into an irrevocable trust for the benefit of the employees, the contributions made to the fund, subject to the rules thereof being acceptable to the income-tax authorities, should be allowable as deduction in the employer’s income-tax assessment.

4. The rules to be framed for such a fund must, however, incorporate the following, among other, specific provisions, namely, that—

   a.   the benefit of the fund shall be open to only those persons who are whole-time bona fide employees of the employer, having no substantial shareholding interest;

   b.   the trust money shall be invested in such trusted securities as are payable both as regards capital and interest in India;

   c.   the gratuity shall be made payable and shall be paid only in India;

   d.   the trustees shall be responsible for deduction of tax from the gratuities and crediting the tax so deducted to the Government Revenue;

   e.   no amendment of the rules of the fund shall be made without the approval of Central Board of Revenue;

    f.   the contributions shall be made on a reasonable basis acceptable to the Income-tax Department, i.e., either on actuarial basis or any other basis having regard to the length of service of each employee concerned;

   g.   so much of the contributions as cannot properly be treated as ordinary annual contributions shall be treated by the Commissioner of Income-tax in the same manner as is adopted by the Central Board of Revenue to deal with similar contributions to an approved superannuation fund.

5. As stated above, there is no question of any formal approval of any gratuity fund as such under the law. All that the employers want, however, is that the rules of the gratuity funds being found satisfactory, the contributions made by the employers should be allowed as a deduction in computing their profits. The Board have given careful consideration to this request and have decided that if the rules of a gratuity fund, duly constituted under an irrevocable trust, satisfy the conditions laid down in para 4 above, the contributions made by the employers may be allowed as a deduction in their income-tax assessments. The rules need not to be forwarded to the Central Board of Revenue for "approval".

The Commissioner concerned should, after going through the rules in each case, issue necessary instructions to the Income-tax Officer.

6. The matter of arriving at the tax relief in respect of the "initial contributions" will be as indicated in the illustration of the hypothetical case given below :

1. The employees in respect of whom the extraordinary contribution is made are, say, A, B and C.

2· The earliest year when any of them was in the employer’s service is, say, 1938.

3. The extraordinary contribution in question is, say, Rs. 9,000 made in 1943.

4. Aggregate salaries:

5. Allocation according to assessment years :

6. Income-tax and super tax rates :

  7. Tax relief :

This relief will be allowed whole in the year of assessment in respect of the year in which such initial contribution is made.

CLARIFICATION 2

RULE 104 OF INCOME-TAX RULES - INITIAL CONTRIBUTION - WHETHER CAN BE MADE IN INSTALMENTS - Rule 104 lays down that any initial contribution in respect of the past services of an employee admitted to the benefits of an approved gratuity fund shall not exceed 8¹ / ₃ per cent of the employee’s salary for each year of his past service with the employer.  It has been represented to the Board that insistence, under the above rule, on the entire initial contribution being made in one year, i.e., the year in which the employee is admitted to the benefits of the fund, would result in hardship to several employers upsetting their whole business organisation and that the initial contribution may be permitted to be made in instalments.  The matter has been examined by the Board and it has been decided that the initial contribution may be permitted to be made in not more than five annual instalments commencing from the year in which the employee has been admitted to the benefits of the fund.

Circular : No. 14 [F.  No. 19/4/69-IT(A-II)], dated 23-4-1969.

CLARIFICATION 3

Application for approval- The suggestion made was that the requirement of rule 4 of Part C of the Fourth Schedule to the Income-tax Act, under which copies of the accounts of the fund for the last three years have to accompany the application for approval, should not apply in the case of newly established gratuity funds.

The Committee was informed that instructions had been issued to the Commissioners to the effect that while according approval to a gratuity fund, they might, after considering all the relevant facts of the case, accord such approval with retrospective effect from the date from which the Fund satisfied the requirements of rule 3 of Part C of the Fourth Schedule.  This would ensure that, even though the fund had to wait for at least three years from its inception before applying for approval in order to satisfy the requirement of rule 4, the approval may, in deserving cases, be accorded from the date of inception of the fund.

Source : Extracts from Minutes (Item 31) of Ninth Meeting of DTAC held on 5-11-1966.