Rule 318 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.
Rule 318 of the Income-tax Rules, 2026 lets gratuity fund moneys sit with a Post Office or scheduled bank or fund a Group Gratuity Scheme with an insurer, with the residue invested per a 2015 notification; rules 321 and 322 cap contributions at 8 1/3% of salary.
Where the money may go
Sub-rule (1) of rule 318: all moneys contributed to the fund or received or accrued by way of interest, or otherwise, may be:
- (a) deposited in a Post Office Savings Bank Account in India; or
- (b) deposited in a current account or in a savings account with any scheduled bank; or
- (c) utilised for the purpose of making contributions under a Group Gratuity Scheme entered into with the Life Insurance Corporation of India or any other insurer as defined in section 2(58) of the Act.
Sub-rule (2): funds not so deposited or used shall be invested in accordance with the Ministry of Finance (Department of Financial Services) notification F. No. 11/14/2013-PR dated 2 March 2015, as amended from time to time. The 1962 parallel is rule 101.
Clause (c) is where rule 318 parts company with its superannuation counterpart. Rule 303(1)(c) lets superannuation moneys be applied to a scheme of insurance or the purchase of annuities under rule 307, because that fund's purpose is to pay a stream of income. A gratuity fund pays a lump sum on exit, so clause (c) points instead to a Group Gratuity Scheme with the LIC or another insurer — a policy that funds and pays the lump sum liability. There is no rule 307 equivalent in the gratuity code, and no commutation rule, because there is no annuity to commute.
The residual investment notification is the same one rule 303(2) uses for superannuation funds — the 2 March 2015 Department of Financial Services notification. It is not the labour ministry notification of 29 May 2015 that governs provident fund investment under rule 292. An employer running all three funds tracks two notifications, not three.
The 8 1/3% ordinary annual contribution
Rule 321: the ordinary annual contribution by the employer to a fund:
- shall be made on a reasonable basis, as may be approved by the approving authority;
- having regard to the length of service of each employee concerned; and
- shall not exceed 8 1/3% of the salary of each employee during each year.
The 1962 parallel is rule 103.
Rule 321 does more than set a ceiling. Before the 8 1/3% even comes into play, the contribution must be on a reasonable basis approved by the approving authority, arrived at having regard to the length of service of each employee. Its superannuation counterpart, rule 305, has no such requirement at all. So a gratuity contribution is not simply "any figure up to the cap": it must rest on an approved actuarial or service-linked basis, and the cap then trims the result. Funding at the full 8 1/3% for every employee regardless of service is not a reasonable basis and is not what the rule contemplates.
Note also what rule 321 does not say. There is no reduction for provident fund contributions. The 27% superannuation ceiling in rule 305 is expressly reduced by provident fund contributions for the same employee in the same year; the 8 1/3% gratuity ceiling stands on its own. Gratuity funding therefore sits alongside the combined provident and superannuation ceiling, not inside it.
Initial contributions for past service
Rule 322: the amount allowable as a deduction for an initial contribution which an employer may make in respect of the past services of an employee admitted to the benefits of a fund shall not exceed 8 1/3% of the salary of the employee for each year of his past service with the employer. The 1962 parallel is rule 104.
| Feature | Rule 321 — ordinary annual | Rule 322 — initial |
|---|---|---|
| Covers | The current year | Past services of an employee admitted to the fund |
| Rate | 8 1/3% of salary during each year | 8 1/3% of salary for each year of past service |
| Basis condition | Reasonable basis approved by the approving authority, having regard to length of service | None stated in the rule |
| Provident fund reduction | None | None |
The wording of rule 322 is 8 1/3% of the salary of the employee for each year of his past service — his salary in each of those years. It is not 8 1/3% of today's salary multiplied by years of service, which for a long-serving employee whose pay has risen would produce a much larger and unsupportable figure. The employer therefore needs the historical salary record for every year being funded. Note also the entry condition: the deduction is for the past service of an employee admitted to the benefits of the fund — so admission under rule 318's companion rules comes first, and the past-service funding follows.
How the three rules fit
- Rule 318 — what the trustees may do with the money.
- Rule 321 — how much the employer may put in each year, on an approved basis.
- Rule 322 — how much it may put in at the outset for service already rendered.
- Rule 324 then prevents any of it coming back to the employer.
Worked example
| Facts | Position under rules 318, 321 and 322 |
|---|---|
| Trustees pay premiums under an LIC Group Gratuity Scheme | Permitted — rule 318(1)(c) |
| Trustees buy annuities for retiring employees | Not the gratuity route — clause (c) is a Group Gratuity Scheme |
| Scheme taken with a private insurer | Permitted — any insurer within the definition |
| Residue invested per the labour ministry pattern | Wrong notification — use the 2015 DFS notification |
| Employer contributes 8 1/3% for every employee regardless of service | Not a reasonable basis having regard to length of service |
| Actuarial basis approved by the approving authority | Contribution allowed up to the 8 1/3% ceiling |
| Employer also contributes 12% to a provident fund | The gratuity cap is not reduced |
| Initial contribution computed at 8 1/3% of current salary × 20 years | Overstated — use each past year's salary |
| Past salary records missing for early years | The deduction is hard to support for those years |
| Past-service funding for someone never admitted to the fund | Rule 322 applies to an employee admitted to the benefits |
Compliance checklist
- Use a Group Gratuity Scheme under rule 318(1)(c), not an annuity arrangement.
- Hold uninvested balances only in a Post Office Savings Bank Account or a scheduled bank account.
- Invest the residue per the 2 March 2015 Department of Financial Services notification, as amended.
- Establish a reasonable contribution basis keyed to length of service and get it approved.
- Cap the annual contribution at 8 1/3% of each employee's salary.
- Do not reduce the gratuity cap by provident fund contributions.
- Compute past-service funding on each past year's salary.
- Admit the employee to the fund before claiming a rule 322 initial contribution for him.
Common mistakes
- Contributing the full 8 1/3% flat without an approved service-linked basis.
- Reducing the cap by provident fund contributions, as the superannuation rules require.
- Using the provident fund investment notification.
- Funding past service on current salary.
- Treating clause (c) as permitting annuity purchases.
- Claiming past-service funding for an employee not admitted to the fund.
Which year this governs
The Income-tax Rules, 2026 are made under the Income-tax Act, 2025. The 1962 parallels are rule 101 for rule 318, rule 103 for rule 321 and rule 104 for rule 322, given for tracing only. Verify the current text and the 2015 notification as amended.