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The Revised Payment of Gratuity Act - A Boon for Private Sector Employees

Guest post by: Ranadey consultant

Article Overview: Employees of private sector organizations have a reason to smile. Government of India will be revising the ceiling on gratuity payable and increase it from 3.5 lakh to 10 lakh rupees. The main behind considering this revision proposal has been to bridge the disparity between private sector and government sector employees.

The Revised Payment of Gratuity Act - A Boon for Private Sector Employees

The year 2010 has brought some good news for the employees of private sector organizations. The government of India is considering a proposal to increase the ceiling on gratuity payable from Rs.3.5 lakhs to Rs.10 lakhs.

Current scenario:

The Payment of Gratuity Act, 1972 currently provides that the maximum amount of tax-free gratuity payable to an employee is not to exceed 3.5 lakhs. For a long-time it was argued that the gratuity ceiling needs to be raised keeping in line with the inflation.

As a result, the government raised the ceiling for tax-free gratuity payable to Government employees from 3.5 lakhs to 10 lakhs in the 6th Pay Commission w.e.f 1.1.2006.

As of January 2010, the government had announced that it is considering a proposal to raise the gratuity ceiling for the private sector as-well. The ministry of Labour and Employment had announced that the necessary changes in the legislation have been made and they have been sent for cabinet approval. On Thursday, March 04, the Union Cabinet approved an amendment to the Gratuity Act. to raise the ceiling form 3.5 lakhs to 10 lakhs. The bill to make the amendment will now be presented in the parliament.

Implications:

The major reason for this increase in ceiling is to bring parity between govt. employees for whom the ceiling was raised in the 6^th pay commission and the private sector employees.

This move will especially benefit employees with high salaries whose gratuity amount often crossed the Rs.3.5 lakhs limit. Earlier an employee was allowed to receive gratuity more than the limit especially gratuity obtainable under award or contract but the amount in excess of the limit was taxable under the head ‘Salary’ as per the Income Tax Act. Hence, such employees either had to loose out on the excess gratuity or pay tax on the excess amount depending on the company policy.

The direct effect following the implementation of the proposal would be that the employers who capped the gratuity payable at Rs.3.5 lakhs would have to raise the cap to Rs.10 lakhs. As a result employees would see an increase in their gratuity liability.

Actuarially, the effects of the change in liability ceiling or cap will vary according to the other assumptions of the company policy like its population experience, attrition, salary scale, retirement age etc. These effects are discussed below:

Population experience:

A well- established company with long industrial presence will tend to have more employees with higher service than a recent start-up. Thus an increase in cap will see a rise in its liability which is directly proportional to the service

Attrition rate:

Attrition rate or withdrawal rate also affects the gratuity liability in combination with the other assumptions like salary scale and retirement age. Withdrawal rate affects the calculation of the future service and hence the liability. Thus, a firm with large no. of employees with relatively higher salaries but high attrition rate will have a lower liability than a similar firm with lower attrition rates.

Salary-scale:

The salary scale has the maximum impact on the gratuity liability projections. A company with higher salary-scale assumptions will naturally have a higher liability. Hence gratuity cap increase will increase the liability considerably for such companies.

Retirement age: Retirement age has a mixed effect on the gratuity liability. A higher retirement age coupled with higher discount rates and lower salary scale reduces the gratuity liability thereby reducing the effect of increase in payment ceiling. On the other hand a lower retirement age and discount rate would have the reverse effect.

Recently there is also talk in the industry about increasing the retirement age which would provide some respite to the employers by reducing the effects of the salary scale and payment cap by spreading out the liability..

Conclusion:

While increasing the cap on gratuity payments is a long awaited and widely appreciated change, it is going to increase the employers’ liabilities thereby requiring appropriate measures to be taken in the form of increased contributions to gratuity funds and will reflect on the balance-sheets of the companies. However it is also worthwhile to note that those employers who do not have any cap on their gratuity pay-out will not have any effect on their liabilities. Overall it’s a win- win situation for employees who will not only see an increase in their gratuity but also not have to bear the tax- burden of this increase.

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