Every employee looks forward to gratuity — a reward for years of service. But behind this simple benefit lies a complex framework of taxation and compliance. To prevent double taxation & promote social security, the Income Tax Act introduces Section 10(25)(iv), which exempts specific incomes of approved gratuity funds.
In essence, it ensures that money parked in a trust for employee gratuity is not taxed again until it reaches the employee. Let’s break this down in simpler terms.
What is Section 10(25)(iv) of the Income Tax Act?
Section 10 lists incomes that are wholly or partly exempt from taxation. Clause (25)(iv) specifically covers any income received by the trustees on behalf of an approved gratuity fund. This means that if an organization sets up a gratuity fund and obtains official approval from the Commissioner of Income Tax (CIT), then the interest, dividends, or other income earned by that fund is exempt from tax.
In other words, money contributed to an approved fund grows tax-free until it is paid out as gratuity to employees.
Purpose and Intent Behind the Section
The main objective of Section 10(25)(iv) is to encourage organizations to create structured gratuity funds for their workforce. Instead of maintaining a casual book entry for gratuity liability, the law motivates employers to set up a separate trust & contribute regularly."
By exempting the trust’s income, the Government ensures that funds earmarked for employees remain fully utilized for their benefit without getting reduced by tax burden. This exemption also creates transparency in employee benefit management.
Also Read: Gratuity & Taxes: The Section That Can Put More Money in Your Pocket
Conditions for Claiming Exemption
For a gratuity fund to qualify under Section 10(25)(iv):
- The fund must be approved by the Principal Commissioner or Commissioner of Income Tax.
- Trustees should manage the fund as a separate legal entity.
- The fund must be used only for paying gratuity to employees or their legal heirs.
- Surplus funds can be invested as per the rules laid down by the CBDT (Central Board of Direct Taxes).
If these conditions are met, any income received by the trustees on behalf of the approved gratuity fund is not taxable under the Income Tax Act.
How This Exemption Operates in Practice
Imagine a company — Sunbeam Technologies — creates an approved gratuity trust for its employees. The company contributes a fixed sum each year, & the trust invests it in safe government-approved securities. The interest earned by the trust is exempt from tax under Section 10(25)(iv).
When an employee retires after 15 years, the trust uses that fund to pay her gratuity. She is taxed only to the extent applicable under Section 10(10) — not on the trust’s income. Hence, no double taxation occurs.
Link Between Section 10(25)(iv) and Employee Benefits
This provision safeguards employee welfare funds. Since the trust income remains tax-free, more money accumulates for future gratuity payouts. Companies can also meet their statutory gratuity obligations without liquidity issues.
Additionally, the fund can cover certain incidental costs such as travel expenses for air, rail, and road transport if they relate to settlement or transfer of employees at retirement — provided such expenses are part of approved rules. This makes the fund a practical tool for managing employee benefits in a tax-efficient way.
Difference Between Approved and Unapproved Funds
An approved gratuity fund enjoys tax benefits under Section 10(25)(iv), while an unapproved fund does not.
|
Parameter |
Approved Fund |
Unapproved Fund |
|
Legal Recognition |
Approved by Income Tax Authority |
Not approved |
|
Tax on Trust Income |
Fully Exempt u/s 10(25)(iv) |
Taxable as income of the trust |
|
Employer Contribution |
Allowed as business expense under Section 36(1)(v) |
May not qualify for deduction |
|
Employee Tax Impact |
Exempt within limits of Section 10(10) |
May attract tax at payment stage |
Also Read: Taxability of Subsidies, Grants & Cash Incentives
Tax Treatment at Different Stages
- At the Time of Contribution: Employer payments to the approved fund are treated as a deductible business expense.
- During Accumulation: Any income generated by the fund (interest, dividends, etc.) is exempt under Section 10(25)(iv)."
- At Payout: When the employee receives gratuity, it is exempt under Section 10(10) subject to statutory limits.
Thus, tax relief applies at all three stages — contribution, growth, & disbursement.
Documentation and Compliance Requirements
To maintain exemption status, the trust must:
- Maintain accurate books of accounts & audit reports.
- Invest as per Rule 101 of Income Tax Rules.
- File annual returns as directed by CIT.
- Ensure that no trustee uses fund assets for personal benefit.
Non-compliance can lead to withdrawal of approval & taxability of the entire income.
Judicial View and Precedents
Courts have consistently upheld that the purpose of Section 10(25)(iv) is to protect employee benefits & avoid tax duplication. In several cases, tribunals have ruled that if the fund follows the approval conditions, its income cannot be taxed under “Income from Other Sources.” This strengthens the trustees’ right to claim complete exemption.
How Employees Indirectly Benefit
Although this provision is primarily for employers & trustees, employees gain indirectly because their gratuity corpus grows faster without tax erosion. It ensures financial security during retirement and promotes formal savings culture within organizations.
Example Scenario
Suppose ABC Pvt Ltd creates an approved gratuity fund in FY 2024–25 & invests ₹50 lakhs. The fund earns ₹4 lakhs as interest on government bonds. As per Section 10(25)(iv), this ₹4 lakhs is fully exempt from tax. When employees receive gratuity after retirement, they are taxed only as per Section 10(10), not on the fund’s interest.
This creates a tax-neutral cycle where contributions and growth are both protected.
Also Read: Ex Gratia Exemption in Income Tax Section
Why This Matters for Companies and Startups
For emerging companies and SMEs, having an approved gratuity fund adds credibility & helps retain talent. It also simplifies compliance when auditors or tax officers seek evidence of employee benefit provisions. Moreover, since trust income is exempt, funds grow faster and require smaller future contributions.
Conclusion
Section 10(25)(iv) plays a key role in maintaining fairness within India’s tax & retirement ecosystem. By exempting any income received by the trustees on behalf of an approved gratuity fund, it ensures that employee benefits reach their intended recipients without tax leakage. Even expenses such as travel expenses for air, rail, and road transport linked to employee settlements can fall within the fund’s scope if approved by the authorities.
This clause stands as a reminder that the Income Tax Act balances revenue collection with employee welfare — a core principle of India’s financial policy.
If you want to establish an approved gratuity trust or optimize tax benefits under Section 10(25)(iv), our CA team can assist you. Visit CallMyCA.com to get personalized guidance for compliance, fund approval, & tax-efficient gratuity management.
