India Inc faces higher gratuity provisioning

Over 50 per cent of Indian companies will have to make higher provisions in their balance sheets as gratuity expenses. This follows last week's Union Cabinet decision to raise the tax-free ceiling of gratuity payable to private sector employees from Rs 350,000 to Rs 10 lakh (Rs 1 million).

According to a survey by leading consultancy firm Tower Watson, half of the Indian companies now provide gratuity purely in line with the Payment of Gratuity Act, 1972 - that is a maximum of Rs 350,000 per employee. Thirty per cent of the firms - mostly big companies - had no ceiling on the gratuity amount.

The remaining 20 per cent of the companies follow different methods of calculating gratuity. The survey covered 210 gratuity schemes covering 350,000 employees.

The PG Act has laid down the guidelines for payment for gratuity, under which employees with a minimum of five years experience are entitled to around half month's salary per year. Under the Act, companies have to provide for this "accrued liability" up to a maximum of Rs 350,000.

Companies typically put this money in their own trusts or with the Life Insurance Corporation of India or other insurance companies.

For instance, Infosys has an Infosys Technologies Limited Gratuity Fund Trust under which the trustees administer the contributions made to the trust and ensure that they are invested in instruments permitted by the law.

At present, contributions made by a company to an approved gratuity trust up to a maximum of 8.33 per cent of annual wages attracts a tax rebate at the hands of the company.

Now the increase in the limit to Rs 10 lakh will force companies to keep aside higher amounts, not just for employees who have already accrued a benefit of Rs 350,000 but also for those who will exceed the limit in future due to expected salary growth. As a result, the report also expected a dramatic increase in their profit and loss provisioning.

However, there could be some breathing space for companies. Despite the government's decision, there has to be an amendment in the PG Act to permit companies to pay more. After that, the Income Tax Act has to be amended so that the exemption limit can be increased to Rs 10 lakh.

Till these laws are amended it is not clear whether the new limit will be effectively restrospectively or prospectively, though experience suggests the latter. For instance, while accepting the Sixth Pay Commission's recommendation of raising the gratuity limit from Rs 350,000 to Rs 10 lakh for central government employees, the government had implemented it in retrospect from 2006.

If a similar provision is made, companies will have to provide for the service that an existing employee has already rendered. Also, if an employee had reached the Rs 350,000 limit a few years ago and the company had stopped provisioning for the gratuity expense, it will have to make the provision in retrospect.

"In this year's P&L, the main impact will come through the recognition of expense related to 'vested past service record' and any recognition of 'non-vested past service record'," the report added.

The report said since most big companies already have no ceiling for the gratuity amount they would be able to give a higher tax-free benefit to employees. "Over 90 per cent of the BSE-100 companies hold this expense in separate assets," said Kulin Patel, head, employees benefit practice, Tower Watson.

Big companies are quite bullish about this. Yasho Verma, vice president (human resources) LG, South-East Asia, said "This enhanced limit could be a good tool for employee management and retention."

Also, there could be a change in the salary structure for employees. "An employee's compensation is a composite of short-term and long-term benefits. This change is progressive and would have a salient effect on retiral/terminal benefits, both on account of additional gratuity eligibility as well as enhancing cash in hand," added N S Rajan, Partner and Global Leader, Human Resource Advisory, Ernst & Young.

According to Patel, 40 per cent of companies with less than 1,000 employees have not fully funded their gratuity schemes, which means they will incur a higher liability now. Rajan said the funded liability of companies could increase because they have to make provisions for an increased gratuity payout.