Compulsory Gratuity Insurance Under the Social Security Code: How Employers Must Fund and Audit Gratuity Liabilities

A gratuity provision sitting quietly on your balance sheet is not the same thing as gratuity money an employee can actually claim from. That gap is exactly what Section 57 of the Code on Social Security, 2020 was written to close, and it is now a live compliance obligation, not a future one. The Code took effect on 21 November 2025, and the Central Government notified the Code on Social Security (Central) Rules, 2026 on 8 May 2026, so the machinery to enforce Section 57 is now fully in place, alongside the state specific rules many states had already notified under the erstwhile Payment of Gratuity Act.

Here is the short version, for anyone who wants the answer before the detail. Under Section 57, every employer other than a Central or State Government establishment must either buy gratuity insurance from LIC or another approved insurer, or set up an approved Gratuity Trust that covers the entire gratuity liability of every eligible employee. There is no third option. A book provision, however carefully calculated, does not satisfy this section on its own.

Why gratuity liabilities have suddenly become a CFO conversation

For years, gratuity was treated as a background HR number, something the actuary updated once a year for the financial statements and nobody in finance looked at closely. Two changes in the Code have pulled it into the boardroom.

The first is the wage definition. Under the new Code, if allowances such as house rent, conveyance, overtime pay, and special allowances add up to more than 50 percent of an employee's total compensation, the excess gets added back into "wages" for calculating gratuity, provident fund, and other social security dues. Companies that structured CTC with a lean basic pay and a heavy allowance stack, which is most companies in India, now face a materially higher wage base for gratuity computation. Run that through the standard formula of fifteen days' wages for every completed year of service, and the liability jumps, sometimes sharply, without a single new employee being hired.

The second is Section 53, which brings fixed term employees into gratuity eligibility after just one year of continuous service, on a pro rata basis, instead of the five year threshold that used to apply only to permanent staff. Every organisation running a large fixed term or contractual workforce, think IT services, BPOs, manufacturing with seasonal hiring, retail, and logistics, now has a gratuity liability for a population it previously excluded from the calculation entirely.

Put these two together and you get exactly the situation actuaries and auditors have been flagging: gratuity liabilities that are growing faster than most finance teams have budgeted for, sitting against funding arrangements that were adequate three years ago and are not adequate today.

What Section 57 actually requires

Section 57(1) says every employer, other than one belonging to or under the control of the Central Government or a State Government, must obtain insurance for gratuity liability, in the manner prescribed, from an insurer regulated by the Insurance Regulatory and Development Authority. LIC is named specifically, but any authorised insurer offering a group gratuity scheme qualifies.

Section 57(2) carves out the exemption. The appropriate government may exempt two categories of employer from the compulsory insurance requirement: an employer who already had an approved Gratuity Fund before this provision applied and wants to continue it, and an employer with 500 or more employees who sets up an approved Gratuity Fund going forward. Both categories still have to demonstrate that the fund covers the full gratuity liability of every employee in the establishment, not a partial or notional amount.

One detail employers often miss: which government is "appropriate" for you depends on your footprint. If your establishment operates in more than one state, the Central Government is the appropriate government and the central rules apply. If you operate in a single state, your state government's rules govern, and several states, Karnataka among the earliest, had already notified their own compulsory gratuity insurance rules before the Code itself came into force. If your state has a notified rule and the central rules also apply to you, treat the stricter of the two as your compliance floor.

Insurance policy or approved trust: how the two routes actually compare

Employers usually ask which route is cheaper. That is the wrong first question. The right first question is which route fits your headcount, your cash flow pattern, and how much control you want over the fund's investments and administration.

The insurance route means you buy a group gratuity policy, typically from LIC, and pay an annual premium calculated on your actuarial liability. LIC (or the insurer) manages the fund and pays out gratuity directly to exiting employees on your instruction, the Controlling Authority even has the power to recover gratuity dues directly from the insurer if you default. This route suits smaller and mid sized employers who do not want the governance overhead of running a trust, and it works for any headcount, there is no minimum employee count to buy a policy.

The approved Gratuity Trust route means you set up your own irrevocable trust, get it recognised under the Income Tax Act, and fund it periodically based on actuarial valuation. This is available to employers who already run an approved fund, and separately, to any employer with 500 or more employees who wants to set one up fresh. Trusts give you more control over investment strategy within the permitted categories, and larger organisations often find the long run cost of managing their own trust comes in lower than a standard insurance premium once the fund matures. The tradeoff is administrative: you need trustees, a trust deed, annual filings, and ongoing income tax compliance.

A quick way to decide: if you are under 500 employees, the insurance route is your only compliant option unless you already run an approved fund. If you are above that threshold, run the actual cost comparison, factoring in trustee administration, actuarial valuation fees, and audit costs against the insurer's premium quote, before you commit either way.

Setting up an approved Gratuity Trust: what the process actually involves

If you qualify for the trust route and decide it is worth the effort, here is what the setup realistically looks like.

You start by drafting and registering a trust deed under the Indian Trusts Act, 1882. The rules are specific about governance: the trust needs five trustees, and the number representing the employer cannot equal the number representing employees, so you cannot have a two and two split, it has to be an uneven representation. The trust must be irrevocable, which means once you fund it, that money is legally committed to paying employee gratuity and cannot be pulled back into general corporate funds.

Next comes income tax recognition. A trust deed alone does not get you the tax benefits, you need approval from the Principal Commissioner of Income Tax under Rule 4 of Part C of the Fourth Schedule to the Income Tax Act, 1961, and the fund needs to meet the definition of an approved gratuity fund under Section 2(5) of that Act. This is the step many employers underestimate on timeline, the approval process involves documentation review and can take several weeks to a few months depending on the jurisdiction and how clean your application is.

Once approved, contributions you make to the trust become tax deductible business expenses under Section 36(1)(v) of the Income Tax Act, and gratuity paid out to employees stays exempt up to Rs 20 lakh under Section 10(10). That combination, deductible contributions and tax free payout for the employee, is the financial engineering piece that makes the trust route genuinely attractive for large employers, not just a compliance checkbox.

The trust also has to invest its corpus according to the pattern prescribed for recognised provident funds, it cannot simply sit in a current account or chase equity returns. And the trust's financial statements need to follow the applicable accounting standard for employee benefits, whether that is AS 15 for standalone Indian GAAP reporting or Ind AS 19 for companies reporting under the converged standard.

Why actuarial valuation is the piece nobody can skip

Whichever route you take, insurance or trust, an independent actuarial valuation is not optional. It is the document that tells you, your auditor, and eventually a labour inspector, exactly how large your gratuity obligation is on any given date, split between the present value of the defined benefit obligation and the fair value of assets already set aside to meet it.

This matters for three separate audiences at once. Your statutory auditor needs it to recognise the correct liability and any actuarial gain or loss in your financial statements under AS 15 or Ind AS 19. Your insurer or trust needs it to calculate the premium or contribution required to keep the fund fully covered. And a Controlling Authority conducting an inspection needs it to confirm that your insurance or trust arrangement actually covers your full liability, not just a conservative estimate from three years ago that has not been updated since your headcount, wage structure, or attrition pattern changed.

Get the valuation wrong, or worse, skip it and rely on a rough internal estimate, and you end up funding your policy or trust below the real liability. That underfunding does not show up as a problem until an employee actually retires or exits and the payout due exceeds what the fund holds, at which point the shortfall becomes an immediate cash liability on your books, plus a compliance gap you have to explain during any audit or inspection. Annual actuarial valuation, done by an independent actuary and reconciled against your latest wage and headcount data, including the wage definition changes and fixed term employee inclusion under the Code, is the only way to keep that gap from opening up.

Premiums, renewals, and staying on the right side of the Controlling Authority

Once you have a policy or a funded trust in place, the compliance work is not finished, it becomes an annual cycle. You need to pay premiums on time and renew the policy before it lapses, a gap in coverage is treated as a compliance failure even if it was purely administrative. Employers are also expected to intimate the Controlling Authority within 15 days of every renewal, and to keep the authority updated on any change in the list of insured or covered employees.

If you are on the trust route, this becomes annual contribution funding based on the updated actuarial valuation, plus the routine income tax filings and audited accounts a trust is required to maintain to keep its approved status. And under the new central rules, employers covered under the gratuity chapter now also have an annual unified return to file in Form XXIII, due by the 28th or 29th of February each year, with additional filing triggers if the establishment is sold, abandoned, or discontinued.

What non compliance actually costs you

The Code's offence provisions are direct on this point. An employer who fails to pay gratuity due to an employee faces imprisonment of up to one year, or a fine of up to Rs 50,000, or both. A second or subsequent offence involving non payment of gratuity, contributions, or compensation carries a steeper penalty, imprisonment of two to three years and a fine that can go up to Rs 3 lakh. Separately, if gratuity is not paid within 30 days of it becoming due, interest starts accruing on the delayed amount at the rate notified by the Central Government.

There is a compounding route for first time, fine only offences, where you can settle by paying up to 50 percent of the maximum fine and avoid prosecution, and up to 75 percent where imprisonment is involved. That mechanism exists precisely because the government wants voluntary correction rather than courtroom battles, but it only helps you if the underlying non compliance was a genuine lapse and not a pattern. Inspectors under the Code are also required to give a 30 day improvement notice before formal action in many cases, which gives employers a real window to fix a shortfall once flagged, provided you catch it before it becomes an inspection finding rather than a self reported correction.

Central Rules, state rules, and where things stand right now

The Code on Social Security (Central) Rules, 2026 notified on 8 May 2026 operationalise Section 57 alongside provident fund, ESI, maternity benefit, and the gig and platform worker provisions, under one consolidated central framework. If your establishment spans more than one state, these are the rules that apply to you directly.

If you operate within a single state, check whether your state has notified its own compulsory gratuity insurance rules, several did so under the old Payment of Gratuity Act framework and are expected to realign those rules with the Code. Karnataka's 2024 rules are a useful reference point for what state level implementation typically looks like: a Form I application to the Controlling Authority within 30 days of buying insurance, along with the list of insured employees, and a Form II route for employers continuing an existing approved fund. Expect other states to follow a broadly similar structure even as the exact forms and timelines vary.

Where employers most often go wrong

A few patterns show up again and again during audits and inspections. Employers buy a gratuity policy once, at a headcount and wage level from several years ago, and never revisit the sum insured as the company grows or wage definitions change, leaving the policy quietly underfunded. Companies with fixed term or contract heavy workforces continue excluding that population from their gratuity calculation altogether, missing the one year eligibility rule under Section 53 entirely. Trusts get set up but the annual actuarial valuation is treated as a paperwork formality rather than a genuine funding exercise, so the trust corpus drifts below the actual obligation year after year. And multi state employers sometimes apply the wrong state's rules, or assume those rules still control after the central rules came into force for their category.

Every one of these is fixable with a proper review, but they are far easier to fix before an Inspector cum Facilitator finds them than after.

How Praans Consultech helps employers get this right

This is exactly the kind of compliance work that sits at the intersection of labour law, tax law, and actuarial science, which is why most in house HR or finance teams need a partner rather than trying to build the expertise from scratch. Praans Consultech works with employers on the full scope of Section 57 compliance: coordinating independent actuarial valuations aligned to AS 15 and Ind AS 19, comparing the real cost of the insurance route against a Gratuity Trust for your specific headcount and structure, handling trust deed drafting and Income Tax approval under the Fourth Schedule, and building the ongoing calendar of premium renewals, Controlling Authority intimations, and Form XXIII filings so nothing lapses quietly.

If you already have a gratuity policy or trust and are not sure it actually covers your current liability, or if you have never formally assessed which route makes financial sense for your organisation, that is worth a proper review before your next audit cycle or state inspection raises the question for you.

Frequently Asked Questions

Is gratuity insurance mandatory for all employers under the Code on Social Security?
Yes, for every employer other than Central or State Government establishments. Section 57(1) makes insurance from an approved insurer the default requirement, with an exemption available only for employers running an approved Gratuity Trust that covers the full liability of all employees.
What is the employee threshold for setting up a Gratuity Trust instead of buying insurance?
An employer can set up a fresh approved Gratuity Fund and claim exemption from compulsory insurance only if it employs 500 or more persons. Employers who already had an approved fund before this requirement applied can continue it regardless of headcount.
Do I need an actuarial valuation even if I already have a gratuity insurance policy?
Yes. The policy premium and sum insured need to be based on an actuary's calculation of your current liability, and your financial statements separately require an actuarial valuation under AS 15 or Ind AS 19 regardless of which funding route you use.
What happens if my gratuity insurance or trust does not cover my full liability?
The gap becomes a direct cash exposure the moment an employee's gratuity falls due, and it is also a compliance gap that inspectors specifically check for. Continued underfunding can attract penalties under the Code's offence provisions if it results in delayed or unpaid gratuity to an employee.
Which government's rules apply if my company operates in more than one state?
The Central Government is the appropriate government for establishments operating in more than one state, so the Code on Social Security (Central) Rules, 2026 apply. Single state establishments generally follow their state government's notified rules alongside the central framework.

Talk To Praans Consultech

Praans Consultech runs gratuity liability audits, sets up compliant insurance or Gratuity Trust structures, and coordinates the actuarial valuations that keep your funding aligned with Section 57. If your gratuity liability has not been reassessed since the wage definition and fixed term eligibility changes came in, reach out for a free initial review, before an inspection or an underfunded payout forces the review on you.

Call 9050576838 or write to info@praansconsultech.com to get started.

If you would rather not track policy renewal dates, actuarial valuation cycles, Controlling Authority intimations and the annual Form XXIII filing by hand, Praans Consultech also runs a compliance software platform built for exactly this: one dashboard for compliance alerts, registration and licence tracking, and real time audit trails across states. New users get three months free to try it. Read more about it here, if you want: Praans Consultech | AI-driven platform for labour law compliance and business registration in India

About The Author

Sandeep Kumar holds a B.Sc., LLB, LLM, PGCHRM from XLRI, and is pursuing a PhD, and has advised businesses across India on labour law compliance for over 16 years. He is the Co Founder and Labour Law Consultant at Praans Consultech, working on registrations, audits, litigation support, and advisory across the new Labour Codes.

Sources

The Code on Social Security, 2020, Chapter V and Section 57 in particular, bare act as published on indiacode.nic.in
The Code on Social Security (Central) Rules, 2026, notified by the Ministry of Labour and Employment on 8 May 2026
The Payment of Gratuity Act, 1972 and state level Compulsory Gratuity Insurance Rules notified under it, referenced here for continuity with the pre Code framework
The Income Tax Act, 1961, Section 2(5), Section 10(10), Section 36(1)(v), and Part C of the Fourth Schedule, as published on incometaxindia.gov.in
The Indian Trusts Act, 1882
Press Information Bureau, Ministry of Labour and Employment, factsheets and notification summaries on the Code on Social Security, 2020, November 2025

Disclaimer

This article is prepared for general awareness and reads as a plain language summary of the Industrial Relations Code, 2020, the Code on Social Security, 2020, the Code on Wages, 2019, the Occupational Safety, Health and Working Conditions Code, 2020, and related rules. It is not legal advice and should not be treated as a substitute for a formal opinion from a qualified labour law professional. Laws, rules, and their state wise notifications keep changing, and the applicability of any provision depends on the specific facts of a business.

Praans Consultech has prepared this content in good faith based on the bare acts and publicly available government notifications at the time of writing, and recommends verifying the current position against the original gazette text or a qualified consultant before relying on it for any business decision, contract, or compliance action.

Praans Consultech and the author accept no liability for any loss or consequence arising from actions taken solely on the basis of this article.

Compulsory Gratuity Insurance Under the Social Security Code: How Employers Must Fund and Audit Gratuity Liabilities

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