As per Rule 102 of Income Tax Rules 1961, If the director has more than 5% voting shares, then the director is not eligible for gratuity under approved gratuity scheme.

The Rule 102 provides as below:

102. Where the employer is a company as defined in clause (i) of sub-section (1) of section 3 of the Companies Act, 1956 (1 of 1956), a director of the company may be admitted to the benefits of the fund only if he is a wholetime bona fide employee of the company and does not beneficially own shares in the company carrying more than five per cent of the total voting power.

However, if there is a contract or agreement during appointment with the director to pay him gratuity even through he has more than 5% share, then he can become eligible as per the provisions of the Payment of Gratuity Act, 1972. This is as per a judgement of The Hon'ble Bombay High Court in Ramchandar's Coaching Institute Pvt.Ltd. & Anr. vs. Rakesh Ramchandar Nanda.

On The Payment of Gratuity Act, The Hon'ble Court held that:

"In fact, sub-section (5) of Section 4 of the Act, which deals with payment of gratuity, makes it clear that nothing in that section shall affect the right of an employee to receive better terms of gratuity under any award or agreement or contract with the employer. Even if an employee does not fall within the meaning of the definition provided in the trust deed prepared for the purposes for Section 4-A of the Act, nothing prevents an employer company from entering into any agreement with an employee for payment of gratuity."

Section 4(5) of The Payment of Gratuity Act 1972 states that:

Nothing in this section shall affect the right of an employee to receive better terms of gratuity under any award or agreement or contract with the employer.

Thus, on the issue of payment of gratuity to a director holding more than 5% voting rights, the Hon'ble Court held that "Nothing therefore prevents Appellant No.1 company from entering into a separate contract for payment of gratuity with a whole-time employee who has been holding more than 5 per cent voting rights in the company."

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