What is the Tax Proposal?
Provident fund is generally regarded as one of the superannuation benefits where a part of salary is accumulated throughout employment period towards building retirement corpus though withdrawals from PF are allowed for specified purposes. Let us first get clarity on the portion of the Provident Fund that is proposed to be taxed. The existing employee PF contribution including voluntary portion, employers' matching PF contribution, interest earned on both till 31st March 2021 are not taxable. In other words, whatever would be accumulated balance including interest till 31st March 2021 would not be liable for tax. The interest earned on employee PF (EPF or GPF) contribution and voluntary PF (VPF) portion would be taxable when combined PF amount exceeds Rs 250,000/- in a financial year i.e. interest income would be subject to TDS @10% on the portion exceeding Rs 250,000/- and interest earned on excess PF portion will have be added to taxable income w.e.f. 1st April 2021 while filing IT Return. The Provident Fund in its present form is exempt, exempt, exempt on investment, interest earned and withdrawal respectively. In fact, EPF/GPF contribution is eligible for deduction up to a maximum of Rs 150,000/- under section 80C of Income Tax Act, 1961.
Purpose and Impact of Taxation
On an analysis of accumulated PF balances of the employees, Income Tax department reportedly observed that top 100 PF contributors had aggregate Rs 2000 crore or more lying in respective PF accounts. In the low interest regime when Bank depositors earn 6-7 percent interest per annum, which is fully taxable, why higher PF contribution should be allowed to be used as tax-free haven with 8.5% guaranteed returns that has been the trend. The impact of PF interest taxation would be restricted to promoters of corporate, key managerial personnel, HNIs and higher middle class employees, who had started using PF contribution as an investment avenue getting 8.5% tax-free returns in the low interest regime. These top 100 PF contributors were earning a cool tax-free guaranteed interest income of Rs 170 crore @8.5% p.a. on PF balances. The PF interest tax proposal would make Rs 2.5 crore of contribution as tax-free and balance Rs 167.5 crore would get taxed perhaps at highest income tax slab of 42.74%, netting Rs 71.58 crore to the exchequer from just 100 top PF contributors. The employees contributing up to Rs 20,833/- per month towards EPF/GPF + VPF should not be concerned at all.
Illustration
If an employee contributes Rs 300,000/- towards PF (EPF or GPF or EPF/GPF+VPF) in the next financial year 2021-22 then Rs 250,000/- would be exempt from tax. The interest earned on the excess over Rs 250,000/- i.e. Rs 50,000/- will have be added to the taxable income of the employee. However, employer would deduct tax on interest income of Rs 4250/- @8.5% on excess contribution of Rs 50,000/- i.e. TDS amount would be Rs 425/- on interest income of Rs 4,250/-. Now let us take a case of HNI whose EPF or EPF+VPF contribution is Rs 1 crore in next financial year then, in that case, HNI will have to pay tax on the interest earned, at applicable slab rate, on Rs 97,50,000/-. Let us calculate TDS amount of excess PF contribution of Rs 97,50,000/-. The interest income on Rs 97,50,000/- @8.5% works out to Rs 828,750/- where employer would deduct tax at source (TDS) @10% i.e. Rs 82,875/-. Balance amount of income tax at applicable slab rate on interest earned on Rs 97,50,000/- will have to be paid while filing return or as an advance tax. In other words, applicability of tax on PF interest income would be similar to interest on bank fixed deposits when PF contribution exceeds Rs 250,000/- in a financial year.
Public Provident Fund (PPF)
The limit of Rs 250,000/- applies independently on PPF contributions made in a financial year. Since PPF contribution is capped at Rs 150,000/- in a financial year, the taxability of PF interest income will not have any impact. Further, PPF interest rate is reset by GoI at quarterly intervals where extant interest is payable @7.1% p.a. The PPF account continues to enjoy exempt, exempt, exempt (EEE) tax status at the time of investment, interest earned and withdrawal respectively.
National Pension System (NPS)
Government of India has left NPS contributions of employees over Rs 250,000/- untouched where one doesn't get guaranteed returns, rather returns are market linked depending upon combination of Equity, debt and Gilt funds. Further, 60% of the NPS corpus is tax free at the time of withdrawal on retirement and rest 40% has to be necessarily invested for getting fixed period or lifetime annuity which is taxable. The NPS though a retiral benefit doesn't enjoy EEE tax status, rather it is termed as EET where investment and earnings are not taxable but withdrawal is tax-free to the extent of 60% of the accumulated balances at the time of retirement only.
An anomaly is noticed in the entire exercise where GoI had notified an upper limit of Rs 750,000/- for employee PF contributions, NPS contributions or other approved superannuation funds, in the last year's budget. Perhaps one will have to wait till clarity emerges by way of Government Notification when budget is passed in Parliament.
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