WHEN confronted with the choice of opting for a provident fund scheme, the decision often depends on how these gratuity schemes benefit you. It was no different for Arvind, a software engineer, who recently joined TrueSoft. He finds a gratuity clause in his employment contract and a choice of opting for the provident fund scheme. What are provident funds and gratuity anyway? In essence, provident fund and gratuity are retirement benefits, which will help people like Arvind in their retirement years.

Provident Fund (PF):

It is a welfare scheme for Arvind's benefit. Under this scheme, Truesoft will deduct a certain percentage of his basic salary every month and also make a contribution to Arvind's PF account. In essence, the corpus of the fund comprises contributions made by the employee and employer company and the interest earned on such contributions.

There are different types of PF accounts. For government employees, investments are made via salary deductions in statutory Provident Funds. Salary deductions of private sector companies, whose PF are recognised by the commissioner of income tax are invested in recognised PFs.

Some salient points to note about recognised PFs is that you can withdraw the accumulated funds subject to certain conditions and stipulated minimum lock-in period. However, you are free to withdraw on termination of service or on retirement. A minimum five years continuous service is required for a tax-free withdrawal. Thus, in case of a change in the employer, you should transfer the accumulated balance from your old to new RPF account to avail of tax free withdrawal after five years of continuous service. However, there are relaxations available. If the withdrawal is earlier than five years on account of the employee's ill health or discontinuance of the employer's business, the same is exempt.

There is also an unrecognised PF and a voluntary PF (contributions in addition to RPF). A Public Provident Fund (PPF) scheme also exists for individuals, including self-employed professionals where contributions are made by individuals independently. PPF can be opened by anyone with a minimum Rs 500 and maximum of Rs 70,000 per year. You can open an account on behalf of a minor and claim tax benefits.

Gratuity:

It is a gratuitous payment to be made by the employer to Arvind at the time of his retirement in recognition of the services rendered by him. It will be taxable in his hands as "Salary" income, at the time of his retirement. In case, it is received by his legal heir, it would be taxable in the hands of such legal heir as "income from other sources".

Gratuity is exempt from tax as follows:

o Gratuity received on death or retirement of employees of the Central/State government and local authorities is exempt without any limit.

o Gratuity received under the Payment of Gratuity Act, 1972, (PFA) is exempt to the extent it does not exceed 15 days wages for every completed year of service, subject to a maximum of Rs 3.5 lakh.

o For those not covered under PFA, gratuity is exempt to the extent it does not exceed half-amonth's salary for each year of completed service, calculated on the basis of the average salary for 10 immediately preceding months, subject to a maximum of Rs 3.5 lakh. The ceiling of Rs 3.5 lakh applies to the total gratuity received from one or more employers in the same or different years.

Source : Preeti Goel & Anju Thukral - Ernst & Young (THE ECONOMIC TIMES MUMBAI WEDNESDAY 19 DECEMBER 2007)