For years, gratuity in India has operated like that one gym membership people know exists but rarely think about until January arrives.
HR processed it. Finance provisioned for it. Employees remembered it only during resignation.
But things are beginning to change.
With the implementation framework under Chapter V of the Code on Social Security, 2020 coming into effect from 21 November 2025, employers are now looking more closely at how gratuity liabilities are funded and managed. One of the key provisions gaining attention is the requirement around securing gratuity liability either through insurance arrangements or approved gratuity funding structures, subject to exemptions and conditions prescribed by the appropriate government.
Under Section 57(2) of the Code on Social Security, 2020, compulsory gratuity insurance is now the default regulatory requirement. However, once a company crosses the threshold of 500 employees, it unlocks the legal right to bypass compulsory insurance and establish an approved gratuity fund instead.
And suddenly, gratuity has moved from being “HR’s problem” to something finance, compliance, and leadership teams are all discussing together.
Wait, Haven’t Companies Already Been Planning for Gratuity?
Yes, at least on paper.
Most organised businesses already follow the standard provisioning practice of setting aside roughly 4.81% of Basic Salary (or eligible wages) month-on-month to build a gratuity corpus.
The logic is simple:
gratuity = future liability,
future liability = current provisioning.
But here’s where things get interesting.
The Social Security Code introduces a broader wage definition, where wages are expected to constitute at least 50% of total remuneration. That means gratuity calculations may eventually move higher because gratuity is linked to “wages.”
So the question is no longer:
“Are we provisioning for gratuity?”
The real question is:
“Are we provisioning enough?”
Because the difference can become significant over time.
A Simple Example (and a Slightly Painful One)
Imagine two employees with the same annual CTC of ₹12 lakh.
Particulars | Earlier Structure | New Wage Definition Scenario |
|---|
CTC | ₹12 lakh | ₹12 lakh |
Basic Salary | ₹3.6 lakh | ₹6 lakh |
Gratuity Provision @ 4.81% | ₹17,300/year | ₹28,800/year |
Same employee. Same CTC.
But gratuity liability jumps sharply because the wage base changes.
Now multiply that across:
- 3,000 employees,
- annual increments,
- long-tenured staff,
- and multiple locations.
That “small payroll adjustment” suddenly becomes a very large actuarial number sitting on the balance sheet.
Finance teams everywhere collectively looked at their gratuity exposure and probably had the same reaction:
“This feels expensive for something employees only remember during farewell cake-cutting.”
Pre-Code vs Post-Code: What’s Changing?
Area | Earlier Approach | Emerging Post-Code Direction |
|---|
Wage Structure | Flexible salary structuring with lower basic pay common | Wages expected to be at least 50% of remuneration |
Gratuity Liability | Lower due to smaller basic salary base | Potentially higher because of revised wage definition |
Funding Practice | Many companies relied on internal provisioning | Greater focus on insurance / approved gratuity funds |
Compliance Focus | Primarily payout during employee exit | Ongoing liability management and funding readiness |
Large Employer Approach | Mixed practices across industries | Increased discussion around approved gratuity trusts and structured funding |
So, Why Are Companies Suddenly Talking About Gratuity Trusts?
Because gratuity trusts are no longer just a tax consultant’s favourite spreadsheet topic.
They are becoming a practical financial planning tool.
An approved gratuity fund under Part B of Schedule XI of the Income Tax Act 2025 allows organisations to:
build a ring-fenced gratuity corpus,
manage liabilities through actuarial funding,
improve long-term cash flow planning,
and potentially avail tax deductions on contributions made to approved gratuity funds, subject to applicable conditions.
In simple terms, instead of paying gratuity directly from business cash flows whenever employees exit, companies gradually build and manage a dedicated corpus over time.
Think of it as SIP investing except the investment is for future employee exits.
A Real-Life Style Example: The Manufacturing Problem
Consider a manufacturing company operating for 20 years with:
- Stable workforce,
- Low attrition,
- And hundreds of employees completing long tenures together.
Sounds ideal, right?
Until retirement season begins.
Suddenly:
- 25 supervisors retire within one financial year,
- Gratuity payouts spike,
- Cash flow planning gets disrupted,
- Auditors begin questioning unfunded liabilities,
- And finance teams start reworking provisions.
This is exactly where a funded gratuity trust helps.
Instead of scrambling for payouts during peak retirement periods, the company already has:
- Actuarially assessed funding,
- Accumulated corpus,
- And structured liquidity planning.
The liability still exists but the shock reduces significantly.
Another Example: The Startup Surprise
Startups rarely think about gratuity in their early years.
Fair enough. When survival is the priority, nobody opens Excel to calculate employee gratuity projections for 2034.
But consider this.
- A startup scales from 50 to 2,000 employees in six years,
- ESOPs mature,
- Leadership attrition begins,
- And suddenly several senior exits happen together.
The company discovers something interesting:
high-growth hiring creates high-growth gratuity liability too.
Especially when revised wage structures under the labour codes start impacting the gratuity base.
This is why many rapidly scaling companies are now discussing:
- Actuarial valuation,
- Gratuity insurance,
- and approved gratuity trusts much earlier than before.
How Does a Gratuity Trust Actually Help?
Apart from compliance comfort, gratuity trusts offer several practical advantages:
1. Better Cash Flow Management
Instead of sudden large payouts, contributions happen gradually over time.
2. Tax Benefits
Employer contributions to approved gratuity funds may qualify for tax deductions subject to prescribed conditions.
3. Actuarial Discipline
Liabilities are periodically assessed scientifically instead of estimated casually using phrases like:
“I think the gratuity exposure should be manageable.”
Which is not usually an actuarial method.
4. Lower Financial Shock
Retirement-heavy years become easier to absorb because funding already exists.
5. Better Audit Readiness
Auditors and investors typically prefer structured employee benefit provisioning over completely unfunded liabilities.
Especially during:
- Acquisitions,
- Due diligence,
- IPO preparation,
- or financial restructuring.
6. Tax Benefits and Trust Mechanics
Gratuity trusts operate remarkably like a corporate SIP for future employee farewells, separating the legal vehicle (the trust) from the financial product (insurance or investments). Beyond mere compliance comfort, employer contributions to an approved gratuity fund are tax-deductible up to a strict limit of 8.33% of the employee's basic salary per year. This transforms a looming balance sheet threat into a highly efficient, actuary-approved tax optimization strategy.
So, How Does a Company Open a Gratuity Trust?
Thankfully, it’s more structured than complicated. Broadly, organisations typically follow these steps:
Step | Activity |
|---|
1 | Assess gratuity liability through actuarial valuation |
2 | Create an irrevocable gratuity trust |
3 | Appoint trustees |
4 | Draft trust deed and fund rules |
5 | Apply for approval under Part B of Schedule XI of the Income Tax Act 2025 |
6 | Partner with insurer/fund manager if required |
7 | Begin periodic contributions to build corpus |
Many companies work with:
- Actuaries
- Tax consultants
- Insurers
- and labour compliance advisors during this process
And no, this usually doesn’t mean building a separate finance department in a basement with calculators and legal files.
Though sometimes it may feel like it.
The Real Shift Isn’t Legal. It’s Financial.
The new labour code framework is essentially pushing organisations to rethink gratuity as:
- A long-term liability,
- A funding strategy,
- and a balance-sheet planning exercise.
Especially for:
- Manufacturing,
- Retail,
- Healthcare,
- Logistics,
- GCCs,
- and labour-intensive sectors.
Because gratuity liabilities don’t grow dramatically overnight.
They grow silently.
Quarter after quarter.
Increment after increment.
A bit like unread emails. Except more expensive.
So, What Should Companies Really Be Thinking About?
Not panic.
But probably these questions:
- Is our gratuity provisioning aligned with the revised wage structure?
- Have we assessed the impact of the 50% wage definition?
- Should we evaluate an approved gratuity fund?
- Is our actuarial valuation still realistic?
- Are finance, HR, and compliance teams looking at the same numbers?
Because under the evolving labour code environment, gratuity may no longer remain just an employee exit benefit.
It may quietly become one of the most important long-term financial liabilities sitting on an organisation’s books.
7. Beyond Funding: The Need for Visibility
As gratuity liabilities become more closely linked to wage structures, workforce growth and employee tenure, many organisations are discovering that the challenge is not simply calculating gratuity obligations but maintaining visibility over them. HR, payroll, finance and compliance teams often operate with different datasets and assumptions, making it difficult to understand the full extent of future liabilities.
This is where a single source of truth becomes increasingly important. If all the updates related to workforce, payroll and compliance information are brought together at one place, it can help organisations assess gratuity exposure more accurately, improve planning and reduce the risk of unexpected liabilities emerging later.
8. A Digital-First Approach to Workforce Liabilities
The growing focus on gratuity funding reflects a broader recognition that employee benefit obligations can have significant long-term financial implications if not planned for adequately. As organisations seek greater visibility into liabilities that build over time, they are increasingly looking for technology-enabled ways to monitor obligations, evaluate impact and support long-term decision-making.
In many ways, gratuity is becoming an example of a wider trend. Compliance has become more important than just meeting statutory requirements at a particular point in time. It is increasingly about maintaining continuous visibility over obligations and being prepared for their financial impact well before they arise.