Employee Benefit Trusts: Provident Fund, Gratuity, Superannuation and ESOP Trusts

Employers in India commonly use trusts to hold money and shares set aside for their employees: provident fund trusts of exempted establishments, gratuity and superannuation funds, and employee stock option and welfare trusts. The trust form keeps these funds separate from the employer's own assets, so they are protected if the employer fails, and it places them under trustees with fiduciary duties to employees. This note explains each type and the rules that govern it.

1. Why Use a Trust for Employee Benefits?

Segregation: the fund is not the employer's property and is protected from its creditors (Topic 53).
Fiduciary governance: trustees, often including employee representatives, must administer the fund for the members.
Tax approval: approved funds and their contributions receive favourable tax treatment.
Long-term administration: a trust survives changes of management and continues to pay benefits over decades.

2. Provident Fund Trusts

Most establishments contribute to the statutory provident fund administered by the Employees' Provident Fund Organisation. An establishment whose own scheme is at least as favourable may be granted exemption and run its own provident fund trust, subject to conditions laid down by the appropriate government and the EPFO.

Trustees: a board of trustees with employer and employee representatives administers the fund.
Investment: the fund must be invested in the pattern prescribed by the government.
Interest: members must receive at least the rate declared for the statutory fund; the employer must make good any shortfall.
Withdrawal of exemption: breach of conditions can lead to cancellation of the exemption and transfer of the fund to the EPFO.

The Code on Social Security, 2020, which came into force with the other labour codes on 21 November 2025, subsumes the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 and the Payment of Gratuity Act, 1972, and continues the framework for exempted establishments and gratuity. Transitional rules and schemes under the Code should be checked for details.

⚠ Note

An employer who deducts employees' provident fund contributions and fails to deposit them is deemed to have dishonestly used the money in violation of law, which is criminal breach of trust under Section 316 of the BNS (Topic 38).

3. Gratuity and Superannuation Funds

Fund	Purpose	Trust features
Approved gratuity fund	To meet the employer's liability to pay gratuity on retirement, resignation, death or disablement	An irrevocable trust, usually funded through a group gratuity policy with an insurer; approved by the income tax authorities, so that contributions are deductible and the fund's income is exempt
Approved superannuation fund	To provide pensions or annuities to employees on retirement	An irrevocable trust established under an approved scheme, often funded through an insurer; contributions within limits are deductible

Income tax rules have long required such funds to be established under irrevocable trusts with rules ensuring that the money can be used only for the employees' benefits. These rules have been carried into the Income-tax Act, 2025 from 1 April 2026.

4. ESOP and Employee Welfare Trusts

Companies that grant employee stock options or other share-based benefits often route them through an employee welfare trust that acquires and holds shares and transfers them to employees when options are exercised.

Companies Act, 2013, Section 67(3)(b): a company may provide money for the purchase of its fully paid shares by trustees for the benefit of employees, under a scheme approved by special resolution, as an exception to the bar on financial assistance.
SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021: for listed companies, regulate schemes implemented through trusts, including limits on secondary market acquisitions, the trust's voting restrictions, the independence of trustees, holding periods and disclosures.
Fiduciary duties: the trustees must administer the shares under the scheme for the employees, not for the promoters or management.

5. Common Issues

Conflicts of interest: employer-nominated trustees must not prefer the employer's interests over members' (Sections 51 and 88; Topics 24 and 35).
Investment discipline: prescribed investment patterns override the general rules of Section 20 of the Trusts Act.
Insolvency: provident, pension and gratuity funds are excluded from the employer's liquidation estate under the IBC (Topic 53).
Tax approval: loss of approval can make contributions non-deductible and the fund's income taxable.

⚠ Key point

Employers use trusts for provident funds of exempted establishments, gratuity and superannuation funds, and ESOP and welfare schemes because trusts segregate the funds from the employer, impose fiduciary governance and support tax approval. Exempted PF trusts must invest as prescribed and match the statutory interest rate, now under the Code on Social Security, 2020 (in force 21 November 2025). Approved gratuity and superannuation funds are irrevocable trusts. ESOP trusts rest on Section 67(3)(b) of the Companies Act and, for listed companies, the SEBI SBEB Regulations, 2021. Non-deposit of PF deductions is criminal breach of trust.

6. Related Topics and Provisions

Criminal breach of trust (Topic 38): PF and ESI deductions
Taxation of private trusts (Topic 47)
Trust property in insolvency (Topic 53)
Fiduciary disabilities (Topic 24)