INDIA – Mandatory Gratuity Ceiling Increases
Isabel Coles | 28 August 2018
For employees leaving service after 29 March 2018, the Indian government has increased the mandatory gratuity ceiling, which applies to private sector employees covered by the Payment of Gratuity Act, from INR 1 million to INR 2 million.
At the same time, the maximum period of maternity leave to count as part of calculating the period of continuous service for a female employee was increased from 12 weeks to 26 weeks.
A mandatory gratuity is paid by the employer to an employee when an employee leaves service (including on retirement) after completing at least 5 years of service. The amount of the mandatory gratuity payment is based on the employee’s wages and years of service and is capped at a maximum amount – now INR 2 million. Employers can make gratuity payments in excess of the mandatory amount, and a sizeable proportion choose to do so. However, only the mandatory element of the gratuity payment is exempt from income tax.
Employers who do not limit the gratuity payments to the ceiling will see little change with the higher gratuity amount continuing to be payable. However, the tax-free part of the benefit will be higher for employees.
For companies paying gratuities in line with the mandatory requirements, the increase in the gratuity ceiling from INR 1 million to INR 2 million means higher gratuity benefits for employees who were expected to be impacted by the previous ceiling when they left the company.
Under International Accounting Standard 19 (IAS19) and Indian Accounting Standard 19 (IND AS19) companies must disclose a provision for the gratuity benefits in their accounts. The effect of this benefit improvement will affect both the company’s balance sheet position and the profit or loss cost. The benefit improvement will be recognised as a past service cost in profit or loss in the accounting period in which the increase in the ceiling is implemented. There will be a corresponding increase in the value of the liabilities and therefore an overall worsening of the balance sheet position. The extent of the impact will depend on how many employees earn a gratuity above the previous INR 1 million ceiling, and the projected amount of their gratuity. Going forward the company’s P&L expense will also be slightly higher, reflecting the higher gratuity benefit that employees can earn in the future.
As companies approach their financial year-end reporting they should evaluate the impact of the amendment on their disclosure figures. Additionally, companies may wish to review future cash flow requirements, ensure the gratuity plan rules reflect the legislative changes and communicate with employees on improved gratuity benefits. For funded gratuity plans the appropriate amount and timing of contributions to fund the increase in the gratuity obligation should be considered. For unfunded gratuity plans, a review of the expected (higher) benefit cash flows in the short to medium term may be helpful.