5/6/2020 www.taxmann.

com

RULES 98 TO 111 - Approved gratuity funds

RULES 98 TO 111 *
Approved gratuity funds
The statutory background
98.1 Section 2(5) of the Act defines an 'approved gratuity fund' as 'a gratuity fund which has been and
continues to be approved by the Chief Commissioner or Commissioner in accordance with the rules
contained in Part C of the Fourth Schedule'. Under section 36(1)(v) of the Act, any sum paid by the
assessee as an employer by way of contribution towards an approved gratuity fund created by him for the
benefit of his employees under an irrevocable trust is allowable as a deduction in the computation of
income from business/profession. For obtaining the approval, the employer should comply with the
requirements laid down in Part C of the Fourth Schedule to the Act, as well as the requirements laid down
in rules 98 to 111 of the Income-tax Rules.
The contents of the rules vis-a-vis Part C of Fourth Schedule
98.2 The aspects in respect of which mention is made in Part C of the Fourth Schedule, but detailed
requirements are laid down in the rules, are tabulated below:
Rule No. Requirements laid down Rule No. in
in Part C IT Rules
of Fourth
Sch.
3 For receiving and retaining approval, the fund should, in addition to the 99, 100,
conditions in rule 3, satisfy other conditions which the Board may, by rules, 102
prescribe
8(2) Appeal by employer should be in such form and shall be verified in such manner 111
and shall be subject to the payment of prescribed fee
9(1)(a) Board may make rules, prescribing the statements etc. which should accompany 109
the application for approval
9(1)(b) Board may make rules, limiting the contributions of an employer 103, 104
9(1)(bb) Board may make rules, regulating investment of fund moneys 101
9(1)(c) Board may make rules, providing for penalty for assignment or creation of 105
charge by the employee upon his beneficial interest in the fund
9(1)(d) Board may make rules, providing for the withdrawal of approval to the fund —
9(1)(e) Board may make rules, providing for the general purposes, etc. 101A, 106,
107, 108
98.3 Judicial rulings
98.3-1 Rule 103 cannot be invoked when section 40A(7) is applied - The applicability of rule 103 will arise
only when deduction had to be allowed in conformity with section 36(1)(v). After the introduction of
section 40A, rule 103 will have no application. The claim for deduction has to be worked out solely under
section 40A(7) which came into effect from April 1, 1973. It will be incorrect to reduce the quantum of the
"admissible amount" as defined in Explanation 1 by resorting to rule 103. The said Explanation does not
make any reference to the limitation imposed by rule 103 - CIT v. Malayala Manorama Co. Ltd. [1994]
207 ITR 288 (Ker.).
98.3-2 Rule 104 merely lays down a principle - In the case of Addl. CIT v. Balrampur Raj Electric Supply
Co. [1981] 128 ITR 615 (All.), the High Court observed that rule 104 does not specify with any exactitude
1/7
5/6/2020 www.taxmann.com

the actual amount which the assessee is liable to pay as the initial contribution. It lays down the principle
that it shall not exceed one month's salary of the employee for each year of his past service with the
employer.
98.4 Departmental clarifications
98.4-1 The contents of the rules - The requirements laid down in the rules have been elaborately explained
in the Departmental Letter given as Annex 98.1. This may be referred to.
98.4-2 Other matters - The points connected with tax relief in respect of the contributions have been
clarified in Board's Circulars which are given as Annexes 98.1 & 98.2.
Investment of fund moneys
98.5 Under Rule 101, the monies contributed to the approved gratuity fund after the 31st of October 1974
or received or accruing after that date by way of interest or otherwise to the fund has to be deposited in:
(i) Post office saving bank account
(ii) Current account or saving account with any scheduled bank, or
(iii) Utilised for making contributions under the group gratuity scheme entered into with the Life
Insurance Corporation, or, from 23-10-2000, with any private insurer who has been granted
certificate of registration under section 3 of the Insurance Act, 1938.
To the extent that such monies are not deposited or utilised, it has to be invested in Central Government
securities.
ANNEXURES TO RULES 98 TO 111
ANNEX 98.1
CIRCULAR NO. 482 [F. NO. 19/FB/87-TPL], DATED 26-3-1987
CONTRIBUTIONS RECEIVED BY ANY APPROVED GRATUITY FUND - APPROVED MODES
OF DEPOSITING - PART C OF FOURTH SCHEDULE READ WITH RULE 101/67 OF INCOME-
TAX RULES
1. The Government has notified in the Official Gazette dated 9-3-1987, the Income-tax (Second
Amendment) Rules, 1987. The said Amendment Rules amend the provisions of rule 101 of the Income-tax
Rules, 1962 ('the Rules'), with effect from April 1, 1987.
2. Under the existing provisions of rule 101 monies contributed to approved gratuity funds are required to
be deposited in a Post Office Savings Bank Account or a current account with any scheduled bank, or are
required to be utilised for the purpose of making contributions under Group Gratuity Scheme entered into
with the Life Insurance Corporation of India. To the extent such monies are not so deposited or utilised,
they are required to be invested in the modes of investment specified in rule 67(2) of the Rules.
3. Under the amended provisions, the contributions received by any approved gratuity fund on or after
April 1, 1987, will be required to be deposited in a Post Office Savings Bank Account or in a current
account with any scheduled bank or will be required to be utilised for the purpose of making contributions
under Group Gratuity Scheme entered into with the Life Insurance Corporation of India. The contributions
will not be permitted to be deposited in any of the modes of investment specified in rule 67(2).
ANNEX 98.2
CIRCULAR NO. 30 (XLVII-18), DATED 30-11-1984
CONTRIBUTION TO APPROVED GRATUITY FUND - POINTS CONNECTED WITH TAX
RELIEF IN RESPECT OF INITIAL CONTRIBUTION UNDER CLAUSE (v) OF SUB-SECTION
(1) AND APPROVAL OF GRATUITY FUND
CLARIFICATION 1
Treatment of initial contribution - Certain points have been raised in connection with the provisions in the
Income-tax Act, 1961, relating to gratuity funds. These points and Board's comments thereon are as under:
Point No. 1: Paragraph 6 of Board's Circular No. 70(XI-3), dated 3-11-1951 indicates the manner in which
tax relief in respect of initial contribution to a gratuity fund, which has been "informally" approved under
the aforesaid circular, should be calculated. Do these instructions continue to hold good even after the
coming into force of the 1961 Act? If not, how should the initial contribution to approved gratuity funds be
treated.

2/7
5/6/2020 www.taxmann.com

Comments: Section 36(1)(v) provides that any sum paid by an assessee as contribution towards an
approved gratuity fund shall be allowed as a deduction in computing his business income. Rule 104 of the
Income-tax Rules, 1962, provides that the amount to be allowed as a deduction on account of initial
contribution shall not exceed 81/3 per cent of the employee's salary for each year of his past service with
the employer. The aforesaid rule is effective from April 1, 1962, and is applicable to assessments for the
assessment year 1962-63 and subsequent years. The instructions contained in paragraph 6 of the Board's
Circular referred to hereinabove are, therefore, not applicable to assessments for the assessment year
1962-63 and earlier years.
Point No. 2 : Is there any time-limit for payment of initial contributions under rule 104 of the Income-tax
Rules?
Comments : Rule 104 lays down that any initial contribution in respect of the past services of an employee
admitted to the benefits of the fund shall not exceed 81/3 per cent of the employee's salary for each year of
his past services with the employer. The language of the rule implies that the initial contribution has to be
made in the year in which the employee is admitted to the benefits of the fund [see Clarification 2].
Point No. 3 : How should the date of approval of a gratuity fund be reckoned?
Comments: Rule 2(2) of Part C of the Fourth Schedule to the Income-tax Act, provides that the
Commissioner shall communicate to the trustees of a gratuity fund the grant of approval with the date on
which the approval is to take effect. Unlike in rule 78, relating to recognised provident funds, there is no
provision in the rules relating to approved gratuity funds in regard to the date from which the order of
approval in the case of gratuity fund should take effect. Rule 4(1) of Part C of the Fourth Schedule
specifically lays down that an application for approval of a gratuity fund shall be accompanied by two
copies of the accounts of the fund for the last three years for which such accounts have been made up. This
provision contemplates that an application for approval may be made 3 years after the establishment of a
gratuity fund. In order that the benefits of approval for the intervening period may not be denied to bona
fide gratuity funds, the Commissioners may, after considering all the relevant facts of the case, accord
approval to a gratuity fund with effect from the date from which it satisfies the conditions laid down in rule
3 of Part C of the Fourth Schedule.
ANNEX - CIRCULAR DATED 3-11-1951 REFERRED TO IN CLARIFICATION
Contribution to gratuity fund constituted into irrevocable trust for the benefit of employees - Allowance
thereof under the 1922 Act - 1. It has been brought to the notice of the Board that as a result of the award
by industrial courts, textile mills are now compelled to pay their retiring employees gratuities at the
following rates:
1. On the death of an employee while in service - One month's salary for each year of service subject to a
maximum of 15 months' salary to be paid to the deceased employee's heirs or executors or nominees.
2. On voluntary retirement or resignation of an employee - After 15 years' continuous service with the
employers, 15 months' salary.
3. On termination of an employee's service - (a) After continuous service for 10 years but less than 15
years, 3/4 of the one month's salary for each year of service, (b) after 15 years' continuous service, 15
months' salary.
It is also understood that the above award applies not only to future employees but also to the past, present
and future service of employees who are already in service.
2. Certain employers are now contemplating the creation of gratuity funds so as to make provision for the
gratuities referred to above. Under the present income-tax law no amount set apart by way of reserve for
gratuity (or for any other purpose) can be allowed as a deduction in computing the profits for income-tax
purposes but the actual payment of gratuity can be allowed as and when paid, provided that the employer
makes adequate arrangements for deduction and payment of tax from the gratuities.
3. Unlike the provisions in the Income-tax Act relating to recognition of provident funds or approval of
superannuation funds, there is no provision for approving any other type of funds, but section 10(4)(c)
provides that no allowance shall be made in respect of a payment to a provident or other fund established
for the benefit of employees unless the employer has made effective arrangements to secure that tax shall
be deducted at source from any payment made from the fund which are taxable under the head "Salaries".
It would, therefore, appear that the said section contemplates that contributions by employers to funds
other than recognised provident funds or approved superannuation funds or provident funds to which the
Provident Funds Act of 1925 applies, can be considered as an admissible deduction provided that the
3/7
5/6/2020 www.taxmann.com

essential condition (but not necessarily the only condition) referred to in section 10(4)(c) is satisfied. The
Board consider that if a gratuity fund is constituted into an irrevocable trust for the benefit of the
employees, the contributions made to the fund, subject to the rules thereof being acceptable to the income-
tax authorities, should be allowable as deduction in the employer's income-tax assessment.1
4. The rules to be framed for such a fund must, however, incorporate the following, among other, specific
provisions, namely, that—
(a) the benefit of the fund shall be open to only those persons who are whole-time bona fide
employees of the employer, having no substantial shareholding interest;
(b) the trust money shall be invested in such trusted securities as are payable both as regards capital
and interest in India;
(c) the gratuity shall be made payable and shall be paid only in India;
(d) the trustees shall be responsible for deduction of tax from the gratuities and crediting the tax so
deducted to the Government revenue;
(e) no amendment of the rules of the fund shall be made without the approval of Central Board of
Revenue;
(f) the contributions shall be made on a reasonable basis acceptable to the Income-tax Department,
i.e., either on actuarial basis or any other basis having regard to the length of service of each
employee concerned;
(g) so much of the contribution as cannot properly be treated as ordinary annual contributions shall
be treated by the Commissioner of Income-tax in the same manner as is adopted by the Central
Board of Revenue to deal with similar contributions to an approved superannuation fund.
5. As stated above, there is no question of any formal approval of any gratuity fund as such under the law.
All that the employers want, however, is that the rules of the gratuity funds being found satisfactory, the
contributions made by the employers should be allowed as a deduction in computing their profits. The
Board have given careful consideration to this request and have decided that if the rules of a gratuity fund,
duly constituted under an irrevocable trust, satisfy the conditions laid down in para 4 above, the
contributions made by the employers may be allowed as a deduction in their income-tax assessments. The
rules need not be forwarded to the Central Board of Revenue for "approval".
The Commissioner concerned should, after going through the rules in each case, issue necessary
instructions to the Income-tax Officer.
2 6. The matter of arriving at the tax relief in respect of the "initial contributions" will be as indicated in the
illustration of the hypothetical case given below:
1. The employees in respect of whom the extraordinary contribution is made are, say, A, B and C.
2. The earliest year when any of them was in the employer's service is, say, 1938.
3. The extraordinary contribution in question is, say Rs. 9,000 made in 1943.
4. Aggregate salaries:
1938 1939 1940 1941 1942 Total
Rs. Rs. Rs. Rs. Rs. Rs.
A 1,000 1,000 1,000 1,000 1,000
B Nil 1,000 1,000 1,000 1,000
C Nil Nil 1,000 1,000 1,000
1,000 2,000 3,000 3,000 3,000 12,000
5. Allocation according to assessment years:
1939-40 1940-41 1941-42 1942-43 1943-44 Total
1/12 of 2/12 of 3/12 of 3/12 of 3/12 of
9,000 9,000 9,000 9,000 9,000
=750 =1,500 =2,250 =2,250 =2,250 9,000

4/7
5/6/2020 www.taxmann.com

6. Income-tax and super tax rates:

42 pies 45.5 pies 56 pies 63 pies 74 pies
7. Tax relief:
Rs. As. Rs. As. Rs. As. Rs. As. Rs. As. Rs. As.
164 1 335 7 656 4 738 4 867 3 2,781 3
This relief will be allowed wholly in the year of assessment in respect of the year in which such initial
contribution is made.
CLARIFICATION 2
CIRCULAR NO. 14 [F. NO. 19/4/69-IT(A-II)], DATED 23-4-1969
Rule 104 of Income-tax Rules - Initial contribution - Whether can be made in instalments - Rule 104 lays
down that any initial contribution in respect of the past services of an employee admitted to the benefits of
an approved gratuity fund shall not exceed 81/3 per cent of the employee's salary for each year of his past
service with the employer. It has been represented to the Board that insistence, under the above rule, on the
entire initial contribution being made in one year, i.e., the year in which the employee is admitted to the
benefits of the fund, would result in hardship to several employers upsetting their whole business
organisation and that the initial contribution may be permitted to be made in instalments. The matter has
been examined by the Board and it has been decided that the initial contribution may be permitted to be
made in not more than five annual instalments commencing from the year in which the employee has been
admitted to the benefits of the fund.
SOURCE : EXTRACTS FROM MINUTES (ITEM 31) OF NINTH MEETING OF DTAC HELD ON
5-11-1966
CLARIFICATION 3
Application for approval - The suggestion made was that the requirement of rule 4 of Part C of the Fourth
Schedule to the Income-tax Act, under which copies of the accounts of the fund for the last three years
have to accompany the application for approval, should not apply in the case of newly established gratuity
funds.
The Committee was informed that instructions had been issued to the Commissioners to the effect that
while according approval to a gratuity fund, they might, after considering all the relevant facts of the case,
accord such approval with retrospective effect from the date from which the fund satisfied the
requirements of rule 3 of Part C of the Fourth Schedule. This would ensure that, even though the fund had
to wait for at least three years from its inception before applying for approval in order to satisfy the
requirement of rule 4, the approval may, in deserving cases, be accorded from the date of inception of the
fund.
ANNEX 98.3
LETTER BC NO. T-II/256-MISC. 75-76, DATED 15-11-1975, FROM THE COMMISSIONER OF
INCOME-TAX, BOMBAY
PROVISION MADE FOR THE PURPOSES OF PAYMENT OF CONTRIBUTION TOWARDS
APPROVED GRATUITY FUND - DEDUCTION THEREFOR IN TERMS OF SUB-SECTION (7)(b)
- CONDITIONS TO BE COMPLIED WITH FOR SECURING APPROVAL OF FUND
In order that a gratuity fund may receive approval, the trustees of the fund should satisfy certain conditions
mentioned in Part C of the Fourth Schedule to the Income-tax Act and the rules mentioned thereunder.
They are briefly given below :
1. The application for approval of the fund is to be made by the trustees accompanied by a copy of the
instrument under which it is established together with two copies of the rules of the fund. The trust deed
should be on an appropriate stamp paper and the application should bear court-fee stamp worth Re. 1.
2. The application should contain, inter alia, the information such as name and address of the employer,
his business, profession, address of his principal place of business, classes and number of employees
entitled to the gratuity benefits in India and outside India and also place of maintenance of accounts, etc. A
verification in the form mentioned below should also be annexed to the application:

5/7
5/6/2020 www.taxmann.com

"We trustee(s) of the above-named fund do declare that what is stated in the above application is true to
the best of our/my information and belief and that the documents sent herewith are the originals or true
copies thereof."
3. The rules of the fund should contain definitions of "employer", "employee", "contribution", "salary",
"trust", "trustees", "fund", etc. The definitions should conform to the provisions of rule 2 of Part A of the
Fourth Schedule to the Act and rule 98(a) of the Rules.
It may be mentioned that so far as the definition of "salary" is concerned, it should specifically be made
clear that it excludes all other allowances and perquisites except dearness allowance, if the terms of
employment so provide.
4. A provision is to be made to the effect that gratuity is for the employees in the trade or undertaking on
their retirement at or after a specified age or on their becoming incapaci-tated prior to such retirement or
on termination of their employment after a minimum period of service (to be specified in the rules of the
fund) or to the widows, children or dependants of such employees on their death. There should be no
provision for payment of gratuity to an employee while he continues to remain in service. It should further
be mentioned in the rules that the fund is established for the benefit of the employees employed in India.
5. The fund is to be established under an irrevocable trust in India. The date of such establishment should
also be mentioned clearly as per rule 3(a) of the Fourth Schedule and rule 99 of the Rules. There should be
at least two trustees for a fund. If one of the trustees is a company as defined in section 3(1)(i) of the
Companies Act, 1956, prior approval of the Commissioner is necessary. All the trustees should be resident
in India and any trustee who leaves India permanently should vacate his office.
6. There should be a specific provision that the gratuity benefits are payable only in India and such
payments to employees may be made in lump sum or by instalments which may be specified.
7. The rules of the fund should contain a provision for deduction and payment of income-tax and estate
duty wherever leviable at the time of payment of gratuity in accordance with the provisions contained in
the Income-tax Act and the Estate Duty Act.
8. Regarding the admission of directors in the case of a limited company to the benefits of the fund, the
rules of the fund should contain that such director-employee of the company will be admitted to the fund
only if he is a whole-time bona fide employee of the company and does not beneficially own shares in the
company carrying more than 5 per cent of the total voting power.
9. The ordinary annual contribution by an employer to a fund shall be made on a reasonable basis as may
be approved by the Commissioner having regard to the length of service of each employee concerned so,
however, that such contribution shall not exceed 81/3 per cent of the salary of each employee during each
year. The amount to be allowed as a deduction on account of initial contribution which an employer may
make in respect of the past services of an employee admitted to the benefits of a fund shall not exceed 81/3
per cent of the employee's salary for each year of his past service with the employer. Provisions in regard
to the annual contribution and initial contribution should find a place in the rules of the fund on the lines
mentioned above.
10. Another important provision to be incorporated is to the effect that all the moneys belonging to the
fund are invested as per rule 101.
11. There should be a rule prohibiting the assignment of, or creation of a charge upon, the beneficial
interest of an employee in the fund. If not, there should be a provision to the effect that where an employee
assigns or creates a charge upon his beneficial interest in the fund and does not secure the cancellation of
the assignment or charge within two months of the date of receipt of a notice from the Income-tax Officer,
the consideration received for such assignment or charge shall be deemed to be income received by him in
the previous year in which the fact became known to the Income-tax Officer.
12. The employer shall not, under any circumstances, receive any moneys belonging to the fund or have
any lien or charge on the fund. This should be provided in the rules as per the provisions of rule 106.
13. It should also invariably be mentioned that where there is any repugnance between any of the rules of
the fund and the provisions of the Act and the Rules, the repugnant rule will be void and that the trustees
shall, if so required by the Commissioner of Income-tax remove the repugnant rule. Similarly, there should
be a provision to the effect that the trustees'/arbitrator's decision involving an interpretation of the
provisions of the Act and the Rules made thereunder should be communicated to the Commissioner of
Income-tax who is having jurisdiction over the fund. The provisions contained in rule 110, namely, no

6/7
5/6/2020 www.taxmann.com

alteration in the rules, constitution, objects or conditions of an approved fund shall be made without the
prior approval of the Commissioner, should be incorporated in the rules of the fund.
14. Provision in regard to winding up of the fund is to be indicated. It should also be provided that where
the employer's trade or undertaking is to be wound up or discontinued, the trustees shall, with the prior
approval of and subject to such conditions as may be imposed by, the Commissioner of Income-tax make
satisfactory arrangements for the payment of gratuity to the existing beneficiaries. Besides, it should also
be provided in the rules that any arrangements for the winding up of the fund or for its amalgamation with
another fund shall be subject to the prior approval of, and to such conditions as may be imposed by, the
Commissioner of Income-tax.
15. Provisions should also be made that the fund, for any reasons, ceases to be an approved fund, the
trustees shall nevertheless remain liable to tax on any gratuity paid to an employee.
In addition to the above, it is also necessary to state that the administrative expenses incurred by the
employer will not be claimed by him as deduction in his assessment.
16. Nomination form should be as per rule 101A, i.e., in Form No. 40A or in a form as near to it. Such
forms also should form part of the rules of the fund which deal with nomination.
Note : The information as to where the employer is assessed together with Permanent Account Number
may be mentioned in the covering letter while forwarding the application for approval.

* SECTION 36(1)(v) AND PART C OF FOURTH SCHEDULE.

1 Clause (v) of section 36(1) makes a specific provision in this regard.
2 This para is not applicable for the assessment year 1962-63 and earlier years.

7/7