Gratuity is a liability which normally arises according to the length of the service of the employees' of the assessee. The liability would generally accrue year after year. However, due to practical difficulties in computing the deduction allowable on accrual basis, it has been provided under section 40A(7) that deduction on account of provision for gratuity shall be allowed only when:—
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the amount of gratuity has actually become payable during the previous year to the employees' (provided deduction has not been claimed under clause (b) below); or
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when a provision has been made for payment of a sum by way of any contribution towards an approved gratuity fund.
Therefore, no deduction shall be allowed in respect of any provision made for the payment of gratuity to the employees, even though the assessee may be following the mercantile system of accounting, unless it is a provision for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund.
In other words, any provision for unapproved gratuity fund (for meeting future liability) is not deductible.
The following points should be noted—
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An employee retires during the current year. The employer does not maintain any gratuity fund. Gratuity is paid to him during the current year. It is deductible during the current year.
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An employee retires during the current year. Gratuity is payable to him. A part of the amount is paid during the current year and the balance will be paid in the next year. A provision is made towards gratuity in the books of account of the current year for making payment in the next year. The entire amount is deductible during the current year (if no deduction was claimed earlier). In this case, deduction is available during the current year even if provision is made for gratuity fund, which is unapproved.
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A company has 50 employees. To meet future liability to pay them gratuity at the time of retirement, a gratuity fund is created and the employer makes contribution every year. Employers’ contribution to this fund is deductible only if the fund is an approved gratuity fund.
Table showing the Amount Deductible in different Cases : -
| Cases |
Deductible Amount |
CASE-1 :
X retires from the service of Y Ltd. on May 31, 2018. The company pays gratuity of Rs. 1,60,000, according to the provisions of the Payment of Gratuity Act, 1972. Y Ltd. does not maintain any provision for gratuity account. |
Where gratuity is paid during the previous year or where gratuity has become payable during the previous year, it is deductible if no deduction has been claimed on the basis of provisions earlier. Consequently, Rs. 1,60,000 is allowed as deduction for the assessment year 2019-20. |
CASE-2 :
Z Ltd. maintains an approved gratuity fund. A sum of Rs. 1,00,000 being the employer’s contribution towards the gratuity fund, is debited to the profit and loss account for the year ending March 31, 2019. |
Where any provision is made for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, it is allowed as deduction. It is assumed that provisions of section 43B are satisfied . |
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