from Gratuity48 to Gratuity74: Ep03

In our previous post: from Gratuity48 to Gratuity74: Ep01 and from Gratuity48 to Gratuity74: Ep02 we discussed the nature of the Gratuity Expenses under Labor Act 2048 and Labor Act 2074, the difference between the Defined Benefit Plan and Defined Contribution Plan and the issues relating to the recognition of the gratuity expenses for the tax purposes. In the other post: from Gratuity48 to Gratuity74: Ep02 we discussed how the gratuity amount accrued under The Factory and Factory Workers Act, 2016; Labor Act, 2048 and Labor Act, 2074 and changes brought by Contribution based Social Security Fund Act, 2074. 

In this post we will discuss the taxation of the gratuity payments over the years. Significant changes were brought by the followings laws in relation to the taxation of the gratuity payments. 
1. Factory and Factory Workers Act, 2016 
2. Income Tax Act, 2019
3. Income Tax Act, 2031
4. Labor Act, 2048
5. Income Tax Act, 2058
6. Finance Act, 2064
7. Labor Act, 2074
8. Contribution based Social Security Fund Act, 2074

We will discuss how the taxation of the Gratuity existed over the years below: 

Factory and Factory Workers Act, 2016 to Income Tax Act, 2019

Prevalent Labor Law: Factory and Factory Workers Act, 2016
Prevalent Tax Law: Taxes used to be levied through the notices from the Ministry of Finance. Find them at the website of Department of Printing

The Factory and Factory Workers Act, 2016 didn’t have any specific provision for the statutory gratuity. Employees were entitled towards provident fund and pension under the Act. Even where the gratuity payment were made by the Employer above the prevalent Factory Workers Act, there weren’t any specific notices or rulings from the Ministry of Finance for the taxation on gratuity payment. 

Income Tax Act, 2019 to Income Tax Act, 2031

Prevalent Labor Law: Factory and Factory Workers Act, 2016
Prevalent Tax Law: Income Tax Act, 2019

The Factory and Factory Workers Act, 2016 didn’t have any specific provision for the statutory gratuity. Employees were entitled towards provident fund and pension under the Act. Even where the gratuity payment were made by the Employer above the prevalent Factory Workers Act, there weren’t any specific provision under Income Tax Act, 2019 for the taxation of the gratuity payments as gratuity was not constituted under the meaning of remuneration. Instead, the Income Tax Act, 2019 has specifically exempted the incomes derived from the retirement funds irrespective of whether it is contributory or non-contributory. 

Income Tax Act, 2031 to Labor Act, 2048

Prevalent Labor Law: Factory and Factory Workers Act, 2016
Prevalent Tax Law: Income Tax Act 2031

The Factory and Factory Workers Act, 2016 didn’t have any specific provision for the statutory gratuity. Employees were entitled towards provident fund and pension under the Act. Even where the gratuity payment were made by the Employer above the prevalent Factory Workers Act, the gratuity payment were exempted under the Income Tax Act, 2031. Income Tax Act, 2031 specifically excluded medical allowance, daily or travelling allowance, remote area allowance, pocket allowance or leader allowance received by delegates on a foreign tour, casual expenses, Dashain expenses, any amount received in the form of reimbursement, telephone facility granted by the employer institution and also the gratuity and pension, consolidated home leave, sick leave, decoration, medal awarded by His Majesty’s Government, Government corporation, institution devoted to the public utilities and other institution as prescribed; from inclusion in the employment income. These income were also not subjected to application of any withholding income so were not subjected to income tax. The Tax Rates were defined by Annual Finance Acts rather than in Act. 

Labor Act, 2048 to Income Tax Act, 2058

Prevalent Labor Law: Labor Act, 2048
Prevalent Tax Law: Income Tax Act 2031

Labor Act 2048 had not defined employer’s contribution towards the Gratuity. It had only defined how Gratuity Plan should be. So, it is in the nature of Defined Benefit Plan. Rule 23 of the Labor Rules, 2050 had provided that any permanent employee who has served for 3 or more years and retires from service due to age bar or tendering resignation or is relieved from service of the enterprise due to any reason, such worker or employee shall be given lump sum gratuity at the following rate:

  • An amount equivalent to 1/2 of the current monthly remuneration for every year of service rendered for the service of first 7 years,
  • An amount equivalent to 2/3 of the current monthly remuneration which he was receiving lastly for every year of service rendered, to a worker or employee who has served between 7 to 15 years.
  • An amount equivalent to a 1 month’s remuneration which he was receiving lastly for every year of service rendered, to a worker or employee, who has served for more than 15 years.

Income Tax Act, 2031 specifically excluded medical allowance, daily or travelling allowance, remote area allowance, pocket allowance or leader allowance received by delegates on a foreign tour, casual expenses, Dashain expenses, any amount received in the form of reimbursement, telephone facility granted by the employer institution and also the gratuity and pension, consolidated home leave, sick leave, decoration, medal awarded by His Majesty’s Government, Government corporation, institution devoted to the public utilities and other institution as prescribed; from inclusion in the employment income. These income were also not subjected to application of any withholding income so were not subjected to income tax. The Tax Rates were defined by Annual Finance Acts rather than in Act. 

Income Tax Act, 2058 to Finance Act, 2064

Prevalent Labor Law: Labor Act, 2048
Prevalent Tax Law: Income Tax Act 2058

Labor Act 2048 had not defined employer’s contribution towards the Gratuity. It had only defined how Gratuity Plan should be. So, it is in the nature of Defined Benefit Plan. Rule 23 of the Labor Rules, 2050 had provided that any permanent employee who has served for 3 or more years and retires from service due to age bar or tendering resignation or is relieved from service of the enterprise due to any reason, such worker or employee shall be given lump sum gratuity at the following rate:

  • An amount equivalent to 1/2 of the current monthly remuneration for every year of service rendered for the service of first 7 years,
  • An amount equivalent to 2/3 of the current monthly remuneration which he was receiving lastly for every year of service rendered, to a worker or employee who has served between 7 to 15 years.
  • An amount equivalent to a 1 month’s remuneration which he was receiving lastly for every year of service rendered, to a worker or employee, who has served for more than 15 years.

Section 88(1) of the Income Tax Act, 2058 provided that the retirement payment from approved retirement fund is subject to 15% tax. However, the payment of provident fund or gratuity from the approved retirement fund is subject to tax at the rate of 6% on the payment. Furthermore, Rule 20(6) of the Income Tax Rules, 2059 exempts the amounts contributed to a provident fund or a citizen investment trust, of employees or workers, including interest earned by the amount, in the income years prior to the commencement of the Act (2058/12/18) and the amount for gratuity or accumulated leave. 

Finance Act, 2064 to Labor Act, 2074

Prevalent Labor Law: Labor Act, 2048
Prevalent Tax Law: Income Tax Act 2058 and Finance Act, 2064

Labor Act 2048 had not defined employer’s contribution towards the Gratuity. It had only defined how Gratuity Plan should be. So, it is in the nature of Defined Benefit Plan. Rule 23 of the Labor Rules, 2050 had provided that any permanent employee who has served for 3 or more years and retires from service due to age bar or tendering resignation or is relieved from service of the enterprise due to any reason, such worker or employee shall be given lump sum gratuity at the following rate:

  • An amount equivalent to 1/2 of the current monthly remuneration for every year of service rendered for the service of first 7 years,
  • An amount equivalent to 2/3 of the current monthly remuneration which he was receiving lastly for every year of service rendered, to a worker or employee who has served between 7 to 15 years.
  • An amount equivalent to a 1 month’s remuneration which he was receiving lastly for every year of service rendered, to a worker or employee, who has served for more than 15 years.

Section 88(1) of the Income Tax Act, 2058 provided that the retirement payment is subject to 15% tax. Furthermore, Rule 20(6) of the Income Tax Rules, 2059 exempts the amounts contributed to a provident fund or a citizen investment trust, of employees or workers, including interest earned by the amount, in the income years prior to the commencement of the Act (2058/12/18) and the amount for gratuity or accumulated leave. 

Labor Act, 2074 to Contribution based Social Security Fund Act, 2074

Prevalent Labor Law: Labor Act, 2074
Prevalent Tax Law: Income Tax Act 2058 and Finance Act, 2064

With the enactment of the Labor Act, 2074 the contribution towards gratuity changed into a defined contribution plan unlike the defined benefit plan under Labor Act, 2048.

An important and a frequently asked question is: Whether the Gratuity Plan can be managed locally under the Labor Laws of Nepal? Answer: Rule 24 of the Labor Rules 2050 had required an enterprise to establish a separate Fund for the purpose of depositing gratuity amount to be received by worker or employee, that is calculated under Rule 23. Since the gratuity plan under the Labor Act 2048 is a defined benefit plan, and since the prevailing Labor laws and regulations had also not prohibited to locally manage the gratuity plan, this was permissible under Labor Act, 2048. However, once the Labor Act 2075 was introduced the employer was required to deduct an amount equivalent to 8.33% of the basic remuneration of each labour each month and deposit it for the purpose of gratuity in the Social Security Fund in the name of the concerned labour. However, as per Section 53(6) of the Labor Act, 2074 if for any reason the amount of gratuity cannot be deposited in the approved retirement fund, the amount shall be paid out to the employee. 

Section 88(1) of the Income Tax Act, 2058 provided that the retirement payment is subject to 15% tax. Furthermore, Rule 20(6) of the Income Tax Rules, 2059 exempts the amounts contributed to a provident fund or a citizen investment trust, of employees or workers, including interest earned by the amount, in the income years prior to the commencement of the Act (2058/12/18) and the amount for gratuity or accumulated leave.