Understanding the gratuity scheme

Query

I work in the Human Resource Department of a reputed multinational company. I am not very sure about the gratuity scheme and associated income tax benefits, as I hear different opinions from within my peer group. We would appreciate if you can enlighten us on the matter.

Jafrul Islam, Dhaka

Response

Thank you for your query. Gratuity is a discretionary monetary benefit scheme offered by an employer upon completion of service of an employee. For every type of separation, the employee becomes entitled to an amount as either 'compensation' or 'gratuity' (if any), whichever is higher as stated in the relevant provisions under the Bangladesh Labour Act, 2006 (hereinafter referred to as "BLA"). If an organisation does not have any gratuity scheme, the employer is liable to pay compensation – as per the BLA – at the time of separation. Gratuity or compensation payment shall be in addition to any payment of wage/salary in lieu of notice due to separation of service of an employee on different grounds.

An employee will be entitled to gratuity only when he has been in uninterrupted service for more than one year with the organisation. The definition of gratuity stated in section 2(10) of the BLA under which more than six months is considered as a full year. It is worth noting that completion of more than six months of service will be deemed as one year from the second year.

The amount of gratuity depends upon the duration of service. The amount of gratuity increases with the length of the service of an employee. Gratuity is calculated at the mentioned rate as per section 2(10) of the BLA based on the employees' latest basic wages received for every completed year of service'. Withholding of gratuity payment is permissible only in case of dismissal of an employee for misconduct under sections 23(4)(b) and 23(4)(g) of the BLA and not otherwise.

It is noted that by adopting a gratuity scheme within an organisation, an organisation can claim tax rebate against the gratuity fund as well as the employee need not pay income tax on the amount either. It may be also mentioned that as per the Income Tax Ordinance 1984 (hereinafter referred to as "ITO"), gratuity amount up to BDT 2,50,00,000.00 (Taka Two Crore and Fifty Lac) only is not taxable.

However, to avail such income tax benefit, as per section 2(5A) of the ITO, the gratuity scheme needs to be recognised by the National Board of Revenue (NBR) in accordance with the provisions of Part C of the First Schedule of ITO. For such recognition, the organisation needs to create a separate gratuity fund, manage the fund by a board of trustees. To do so, firstly the organisation has to form a trust and an application is to be made in writing by the trustees to the NBR through a prescribed procedure, along with the copy of the instrument (i.e. Trust deed and rules) and other necessary documents as specified in the schedule. The Board, subject to fulfilling the conditions, approves the gratuity fund within three months of the receipt of such application. The auditor shall have to audit the fund account annually as per rules of the fund. The fund will be treated as completely separate from the fund of the organisation. Hence, as per the provisions of the Schedule, income derived from investments or deposits of an approved gratuity fund and any capital gains arising from the transfer of capital assets of such fund shall be exempted from payment of income tax.