Under the Payment of Gratuity Act, 1972, it is employer’s statutory liability to pay 15 days salary (15/26 of a month's wages) for every completed year of service to each of his employees on their exit, for any reason after five years of continuous service, subject to maximum limit of 3.5 lacs. Higher benefits can be paid if the employer so desires.

Gratuity payable to the employees can be paid as and when liability arises and can be claimed as deductible expense under P & L A/c of the relevant financial years. However, the sound system of financial management envisages providing for Gratuity liability every year and claiming the tax benefits as it is mandatory as per Accounting Standards 15 (AS15) to account for the liability on Actual basis.

This can be done by creating a Trust, managed privately or by insurance company and paying the amount to the Trust every year. In case of Privately Managed Trust, investment of funds will have to be done as per Income-Tax Act by the trustees and entire administration of the Trust including Actuarial Valuation will be the responsibility of the Trustees.

In case of insurance company managed trust, the job of investment and actuarial valuation is taken over by the corporation free of charge and in addition, interest is paid by the Corporation on the accumulated funds.

The employer has to pay an initial contribution at the inception of the scheme to secure past Service gratuity. The initial contribution may be paid in lump sum or spread over a maximum period of five years. The corporation determines contribution payable as annual premium, under the policy, on the basis of an actuarial variation of the gratuity liability subject to the statutory limit of 81/3% of the annual wage bill taking into consideration the relevant factors. When the Trustees pay the contribution under the policy, the amount required towards the premium for life insurance benefits is utilized and balance is credited to the running account of the scheme which accumulates at an interest rate declared by insurance company form time to time.

When the contingency of payment of gratuity arises the necessary amount is withdrawn from the running account for making payment. Upon a claim arising by death the gratuity pertaining to the past service is withdrawn from the running account and the balance is paid from insurance company's Life fund.