Gratuity Provision explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Section 40A(7) disallows any gratuity provision made for payment to employees on retirement or termination — with two exceptions: a provision for a contribution to an approved gratuity fund, and a provision for gratuity that has become payable during the year.
From the ICAI Guidance Note on Tax Audit (Revised 2026), the concluding edition under the Income-tax Act, 1961. For tax years under the Income-tax Act, 2025 the corresponding provision must be checked afresh, and the particulars move to Form No. 26 under rule 47 of the Income-tax Rules, 2026.
The prohibition
Paragraph 37.1: under section 40A(7)(a), no deduction shall be allowed in respect of any provision — whether called as such or by any other name — made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason.
The words "whether called as such or by any other name" close the obvious escape. A "liability for terminal benefits", an "employee benefit obligation" or an actuarially determined "defined benefit obligation" for gratuity is a gratuity provision for this purpose, whatever the caption in the balance sheet.
The two exceptions that save a gratuity provision
Paragraph 37.2: under section 40A(7)(b), the deduction shall be allowed in relation to any provision made:
- for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund; or
- for the purpose of payment of any gratuity that has become payable during the previous year.
And the condition on the first exception: the gratuity fund should be approved for the relevant previous year by the Commissioner of Income-tax. If the gratuity fund is not approved for the time being, the assessee would not be able to avail of deduction for any provision made for the payment of a sum by way of any contribution towards that gratuity fund.
The requirement is not that a fund exists, or that an approval was granted at some point. It is that the fund is approved for the relevant previous year. That makes the effective date in the approval order a substantive audit point — a fund approved with effect from a date inside the year supports the gratuity provision only from that date, and an approval that has lapsed or was withdrawn supports none of it.
What the auditor does
Paragraph 37.3: the tax auditor should call for the order of the Principal Commissioner of Income-tax or Commissioner of Income-tax granting approval to the gratuity fund, and:
- verify the date from which it is effective; and
- verify whether the provision has been made as provided in the trust deed, the rules and regulations governing such trust deed, and the PCIT or CIT approval order stipulations.
Paragraph 37.4: in case the provision made for payment of gratuity is not allowable under section 40A(7), the same is to be stated under this sub-clause.
The three amounts to keep apart
A gratuity arrangement generates several figures in the same accounts, and only one of them is the clause 21(e) answer:
| Amount | Treatment | Where it goes |
|---|---|---|
| Actuarial provision for the accruing gratuity liability, not a contribution to an approved fund and not gratuity that became payable in the year | Disallowed under section 40A(7)(a) | Clause 21(e) |
| Provision for a contribution to an approved gratuity fund | Allowable under section 40A(7)(b), subject to approval for the relevant year and the deed and order stipulations | Not at clause 21(e); the actual payment position is tested under section 43B(b) and reported at clause 26 |
| Gratuity that has become payable during the previous year | Allowable under section 40A(7)(b) | Not at clause 21(e) |
The relationship with section 43B is worth stating explicitly: section 43B(b) covers any sum payable by an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, and allows it only on actual payment. So a contribution to an approved gratuity fund clears section 40A(7) and then still has to clear section 43B on payment before the section 139(1) due date — two separate gates, reported at two separate clauses. The gratuity provision that clears neither gate is what clause 21(e) captures.
Worked example
| Item | Amount | Position |
|---|---|---|
| Actuarial charge to the profit and loss account for the gratuity liability | Rs 48,00,000 | Starting point |
| Of that, contribution provided towards the approved gratuity fund | Rs 30,00,000 | Allowable under 40A(7)(b) — subject to section 43B on payment |
| Gratuity that became payable to retiring employees during the year | Rs 7,00,000 | Allowable under 40A(7)(b) |
| Balance of the provision | Rs 11,00,000 | Disallowed — reported at clause 21(e) |
| Of the Rs 30,00,000, amount actually paid to the fund by the section 139(1) due date | Rs 22,00,000 | Rs 8,00,000 unpaid — reported at clause 26(B)(b) |
| The fund's approval order | — | Effective date verified as covering the whole previous year |
Audit checklist
- Identify the gratuity provision by substance, whatever it is called in the accounts.
- Obtain the PCIT or CIT approval order for the fund and check the effective date.
- Verify the provision against the trust deed, its rules and regulations, and the approval order stipulations.
- Split the charge into fund contribution, gratuity become payable and the balance.
- Report only the balance at clause 21(e).
- Carry the fund contribution through to the section 43B test at clause 26.
- Reconcile the actuarial report to the ledger movement before concluding.
Common mistakes
- Treating the whole actuarial charge as allowable because a fund exists.
- Relying on an approval without checking it covers the relevant previous year.
- Missing a provision captioned as a general employee benefit obligation.
- Stopping at section 40A(7) and not testing the contribution under section 43B.
- Reporting gratuity that became payable in the year as inadmissible.