India: Gratuity update – Karnataka compulsory gratuity insurance rules, 2024 notified

published on 31 January 2024 | reading time approx. 6 minutes

The Payment of Gratuity Act, 1972 (“Act”) is applicable to all business establishments ranging from factories, mines, oil fields, plantations, ports, railways, motor transport undertakings, companies, and shops and commercial establishments where ten or more persons or/were employed on any day in the preceding twelve months. Section 4-A of the Act prescribes requirements on employers to obtain an insurance for their liability to pay gratuity to their employees, and to obtain a registration in this regard.

On 10 January 2024, the Government of Karnataka notified the Karnataka Compulsory Gratuity Insurance Rules, 2024 (“Gratuity Rules” or “Rules”) to be read with Section 4-A of the Act. These Rules mandate all establishments falling under the purview of the Act to obtain a valid Insurance Policy towards their gratuity liability within the prescribed time period in the manner elaborated here under. Pursuant to this development, the Government of Karnataka joins the bandwagon with Andhra Pradesh that has notified regulations on compulsory gratuity insurance. This significant move prompts a closer examination of the essential provisions outlined under the Rules and aims to decode the additional compliance requirements of businesses operating within the state of Karnataka.

Applicability »
Registration and compliance requirement under the Rules »
Timeline for Registration »
Payment, reporting responsibilities, and powers of the controlling authority »
Exemptions »
Creation and Management of the Gratuity Trust »
Income Tax Impact »
Conclusion »

Applicability

Business establishments operating in the State of Karnataka where ten or more persons or/were employed on any day in the preceding twelve months.

Registration and compliance requirement under the rules

All employers falling under the purview of the Rules are required to submit an application for registration of their establishment with the Controlling Authority i.e., the Labour Commissioner or Officials authorized by the Labour Commissioner, in the prescribed format, within 30 days from the date of obtaining insurance (in prescribed Form I). The said form shall include details such as number of employees insured, name of the insurance company, insurance policy reference numbers, terms governing insurance policies to be annexed to the form, among other details.

The Rules also prescribe forms to be submitted (Form III), for recording changes in 1) type of insurance policies; 2) change in details of employees or change in number of employees insured; or 3) any other pertinent information (“Changes”), with the Controlling Authority i.e., Labour Commissioner or Officials authorized by the Labour Commissioner.

The employer of the establishment who has obtained valid insurance policy is required under the Rules to make all payments by way of premium to the insurance company and renew the same periodically. The employer shall initiate the process of payment of premium and renewal of policy before the lapse of the policy.

The requirement of obtaining an Insurance Policy in accordance with Rule 3 are summarised as follows:

Timeline for registration

All new employers are required to obtain an Insurance Policy with correct validity within 30 days from the date on which these Rules become applicable (i.e., no later than 30 January 2024) either from the Life Insurance Corporation of India (“LIC”); or any other insurance company incorporated in accordance with any other law applicable to such insurance companies.
All existing employers of already operating establishments have to acquire a valid insurance coverage within 60 days from the date of commencement of these Rules (i.e., no later than 9 March 2024).

Payment, reporting responsibilities, and powers of the controlling authority

Employers are required to ensure that the premium is paid on time and policy is renewed on a regular basis.
Employers are required to notify the Controlling Authority of any Changes within 15 days of the policy's renewal.
In case of disputes, the Controlling Authority appointed under the Payment of Gratuity Act, or any other officer appointed by the state government has been empowered to recover the gratuity payable to the employee from the Life Insurance Corporation of Indian (“LIC”) or from any other insurance company who has provided the insurance.

Exemptions

The Rules exempt employers-

who have established an approved Gratuity Fund and intend to continue with such arrangement or;
who have employed 500 or more persons and who establish an approved Gratuity Fund, from taking compulsory gratuity insurance provided that:

the exempt employers as referenced hereinabove, are required to submit an application in the prescribed form (Form II);
the existing approved Gratuity Fund shall cover the entire liability of all the employees of the establishment and
exempt employers as referenced hereinabove will be required to register a gratuity trust with five representatives, a mix of employers and employees, with the with the registration authority notified under the Indian Trust Act, 1882.

Creation and management of the gratuity trust

The Gratuity Trust, that is required to be maintained as an “irrevocable system”, can be managed privately, by an insurance company, or jointly, with periodic payments made by the employer to the approved Gratuity Trust Fund. The Gratuity Trust will be required to abide by the Indian Accounting Standards 15. It is interesting to note that The Rules also create a joint liability upon the Gratuity Trust and the insurance company for the fulfilment of the liabilities outlined in this Act.

The gratuity trust shall maintain a separate Gratuity Fund. The inflow of contributions to the Gratuity Fund shall be contributory from the employer and non-contributory for the employees. In case of privately managed Trust, investment of funds will attract the provisions of Income Tax Act, 1961, and the Board of Trustees will be held responsible for fund administration, including valuation. In the case of group gratuity schemes from insurance companies, employers must secure schemes approved under Part-C of the fourth schedule of the Income Tax Act, 1961.

The Gratuity Fund is a fully secure fund and prohibits any withdrawals by either the employer or the Gratuity Trust for purposes other than making gratuity payments to eligible employees. The outflow of funds will be only to the eligible employees upon their exit from service.

Income tax impact

As per Sect. 36 of the Indian Income Tax Act, 1961 (“ITA”), any sum paid as an employer by way of contribution towards an approved Gratuity Fund for exclusive benefit of employees under an irrevocable trust is allowable as a deduction, subject to the condition of payment of the contribution.

Sect. 40A of the ITA further reiterates the above and provides that no deduction shall be allowed in respect of any provisions made towards payment of gratuity to employees on their retirement or on termination of employment.

Exception is provided in respect of payment of contribution towards an approved gratuity fund, or payment of gratuity, actually payable during the relevant financial year. Literally, the ITA envisages that tax deduction would be allowed only when there is an approved gratuity fund.

Express procedures have been laid down under ITA for having the gratuity funds approved by the specified tax authorities. There are provisions governing investment of gratuity fund moneys, cap on initial contributions that can be made while newly introducing Gratuity fund in existing organisations as well as limits on annual contributions etc. Funds also derive returns in the form of dividend, interest, appreciation in asset values etc. Exemption towards such income applies to approved gratuity funds and not otherwise.

A question still pertinent to be addressed is that whether payments to insurers now mandated by the above Rules would be automatically allowed in Income tax computations in the absence of an approved Gratuity Fund.

While provisions of the ITA do not expressly provide for this scenario of permitting deduction upon direct payment by employers to insurers, an argument could be explored that if a state law mandates obtaining such a policy, whether deduction shall be possible without an approval from Income Tax towards such a fund.

With the above development, there could be a renewed interest of the Income tax department on the positions adopted by companies in respect of deductibility of payments to insurers by approved gratuity funds or directly by companies. It is therefore suggested that companies re-examine the positions taken in their tax computations with respect to deductibility of gratuity payments/liabilities and adopt a suitable position having regard to the legal Income tax provisions. In any case, it may be advisable to explore possibility of getting such procedural approval requirements to avoid any litigation, given that the contribution amounts increase considerably with growing business and consequential increase in number of employees, remunerations etc.

Conclusion

In conclusion, the Karnataka Compulsory Gratuity Insurance Rules, 2024, established on 10 January 2024, creates a robust mechanism for employers. In addition to obliging appropriate insurance coverage, these rules place a strong emphasis on accountability and transparency by requiring establishments to register and submit employee details.

Employers, both new and existing, must diligently manage premium payments, ensuring timely policy renewals, and promptly notifying the Controlling Authority of any changes. The authority, appointed under the Payment of Gratuity Act, also holds the power to recover gratuity from the insurance provider.

Additionally, consequential impact of tax deductibility would need to be considered by employers while deciding upon a suitable course of action pursuant to the newly introduced Gratuity Rules.

In essence, these rules signify Karnataka's commitment to fair labour practices, ensuring compliance, transparency, and the protection of employees' gratuity benefits.