In Pakistan, many companies offer gratuity schemes to their employees as a form of long-term compensation. These schemes reward employees for their loyalty and service by providing a lump sum payment upon retirement, reaching a specific age, becoming incapacitated, or leaving the company after a minimum service period. However, for tax benefits and legal compliance, these schemes need to be established as Approved Gratuity Funds (AGFs) under the Income Tax Ordinance, 2001.
This article delves into AGFs in Pakistan, explaining their advantages, the requirements for approval, and the application process. We’ll also explore how these funds operate and the benefits they offer to both employers and employees.
Benefits of Approved Gratuity Funds
There are several advantages to establishing and utilizing an AGF:
- Tax benefits for employers: Contributions made to an AGF are considered a deductible business expense, reducing the taxable income of the employer. This can lead to significant tax savings for companies, making AGFs a financially attractive option.
- Tax benefits for employees: Up to 50% of the gratuity received by an employee from an AGF is exempt from income tax, subject to certain conditions. This incentivizes employees to stay committed to the company for the long haul.
- Improved employee morale and retention: AGFs offer a sense of security and long-term financial planning for employees, potentially boosting morale and reducing employee turnover.
- Structured and transparent system: AGFs operate under a set of rules and regulations, ensuring transparency and fairness in the administration of gratuity payments.
Requirements for Approval of a Gratuity Fund
The Income Tax Ordinance establishes specific criteria that a gratuity fund must meet to be approved by the Commissioner of Income Tax:
- Irrevocable Trust: The fund must be established under an irrevocable trust specifically linked to a trade or undertaking carried on in Pakistan. This ensures that the funds are dedicated to employee benefits and cannot be withdrawn by the employer.
- Minimum Employee Coverage: At least 90% of the employees in the trade or undertaking must be employed in Pakistan. This ensures the fund primarily benefits employees contributing to the Pakistani economy.
- Sole Purpose: The sole purpose of the fund must be to provide gratuities to employees in various scenarios, including:
- Retirement at a specified age or later.
- Incapacitation before retirement.
- Termination of employment after a minimum service period (defined in the fund’s regulations).
- Death (with benefits payable to dependents)
- Employer Contribution: The employer in the trade or undertaking must be a contributor to the fund, demonstrating their commitment to the scheme.
- Benefits Payable in Pakistan: All benefits granted by the fund must be payable within Pakistan.
Example:
ABC Ltd., a manufacturing company based in Karachi, Pakistan, decides to establish a gratuity scheme for its employees. They create an irrevocable trust and draft rules outlining eligibility criteria, contribution amounts, and payment procedures. The rules specify a minimum service period of five years for gratuity eligibility. ABC Ltd. also becomes a contributor to the fund. If the Commissioner of Income Tax finds the scheme compliant with all the requirements, it will be approved as an AGF.
Application Process for Approval
The application for AGF approval is submitted to the Commissioner of Income Tax by the trustees of the fund. The application must be accompanied by the following documents:
- Trust Deed: A copy of the instrument establishing the irrevocable trust for the gratuity fund.
- Fund Rules: Two copies of the fund’s rules and regulations, outlining its operation and administration.
- Financial Accounts (Optional): If the fund has been in existence for any period before the application, two copies of its audited accounts for the preceding three years are required.
- Additional Information: The Commissioner may also request further information as needed.
Compliance Requirements
Once an AGF is approved, the trustees are responsible for ensuring its ongoing compliance with the Income Tax Ordinance and its own set of rules. This includes:
- Maintaining proper records of contributions and payments.
- Timely filing of tax returns for the fund.
- Notifying the Commissioner of any changes made to the fund’s rules or regulations.
Conclusion
Approved Gratuity Funds offer a win-win situation for both employers and employees in Pakistan. Companies benefit from tax savings and improved employee relations, while employees gain long-term financial benefits and a sense of security. Understanding the requirements, application process, and benefits associated with AGFs can help businesses make informed decisions about establishing and managing these valuable employee incentive schemes.
