An update on provident funds in India, and the new taxation norms for EPF
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Provident Funds in India - New taxation norms 2021
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- The story: On 31st of August 2021, the government notified the rules for taxing the interest earned on provident fund (PF) contributions beyond a limit.
- Budget 2021-22: The announcement was made in February Budget, pertaining to interest income on contributions made to the Employees’ Provident Fund (EPF) beyond Rs 2.5 lakh (for private sector employees) and Rs 5 lakh (for government sector employees - who invest in GPF).
- Starting 2021-22, the government will tax interest on contributions made in excess of these limits
- Separate accounts will be maintained within the provident fund account for 2021-22 and subsequent years for taxable contribution and non-taxable contribution made by an individual
- An amendment to the Finance Bill, 2021 proposed to double the cap on contribution from Rs 2.5 lakh to Rs 5 lakh for tax-exempt interest income, if the contribution is made to a fund where there is no contribution by the employer.
- With this, the government provided relief for contributions made to the General Provident Fund that is available only to government employees and there is no contribution by the employer.
- Tax on EPF contributions: In February '21, the Budget proposed that tax exemption will not be available on interest income on PF contributions exceeding Rs 2.5 lakh in a year. It will impact those who contribute more than Rs 2.5 lakh in a year. Existing corpus or the aggregate annual interest on that is unaffected.
- Specific rules: In an amendment to the Income-Tax Rules, 1962 that will come into effect from April 1, 2022, the Central Board of Direct Taxes (CBDT) has inserted Rule 9D, according to which income through interest accrued during the previous year that is not exempt (over Rs 2.5 lakh for private and Rs 5 lakh for government employees) shall be computed as the interest accrued during the previous year in the taxable contribution account.
- The EPFO is yet to formalise the separation of taxable and non-taxable contribution in their accounts.
- Data will need to be aggregated and then the separate accounting process has to be determined for such accounts. It's a tough process to finish.
- The CBDT has stated that the closing balance on March 31, 2021 and the interest accrual on it will be treated as the non-taxable component.
- Why the change: The government had found instances where some employees were contributing huge amounts to these funds to get the benefit of tax exemption at all stages — contribution, interest accumulation and withdrawal. To exclude high net-worth individuals (HNIs) from the benefit of high tax-free interest income on their large contributions, the government proposed to impose a threshold limit for tax exemption, beginning April 1, 2021.
- Logic of PF: Government said that the fund was for the benefit of the workers, and they won't be affected. Big-ticket money which comes into it because of tax benefits and assured (about) 8% return will be taxed. Even sums to the extent of Rs 1 crore were being put into this each month. For somebody who puts Rs 1 crore into this fund each month, what should be his salary?
- Tax slabs: For an individual in the higher tax bracket of 30%, the interest income on contribution above Rs 2.5 lakh would get taxed at the same marginal tax rate. If an individual contributes Rs 3 lakh every year to the provident fund (including the voluntary PF contribution) then the interest on his contribution above Rs 2.5 lakh (i.e. Rs 50,000) will be taxed. The interest income of Rs 4,250 (8.5% on Rs 50,000) will be taxed at the marginal rate. For an individual contributing Rs 12 lakh in a year, the tax will be applicable on interest income on Rs 9.5 lakh (Rs 12 lakh minus Rs 2.5 lakh), and it would be Rs 25,200. The interest income on the additional contribution (over Rs 2.5 lakh for private and Rs 5 lakh for government employees) for a year will get taxed every year.
- Knowledge centre:
- Provident Funds in India - Provident Fund is a savings scheme, a form of social security, and a retirement plan. There are three types – (i) General Provident Fund (GPF), (ii) Public Provident Fund (PPF) and (iii) Employees Provident Fund (EPF or PF).
- GPF or General Provident Fund - It is a PPF account for all government employees in India, allowing them to contribute a certain percentage of their salary. The total amount accumulated during the employment term is paid at retirement to the employee. The rate of interest of GPF is revised periodically and was 7.1% in April 2021.
- PPF or Public Provident Fund - It is also a government-backed long term savings scheme, launched in 1968 under the Public Provident Fund Act 1968. Here both salaried and self-employed people having business income, can subscribe. So, anyone can subscribe to the PPF, voluntarily. But GPF and EPF subscriptions are compulsory for the eligible employee(s).
- EPF or PF - Provident Fund is what the EPF or Employees' Provident Fund is commonly known as. Employees of companies registered under the EPF Act can invest in the EPF or PF. Both the employer and employee are required to contribute 12% of the employee's basic salary and dearness allowance every month to the EPF account. (The employer contributes 8.33 per cent towards Employees' Pension Scheme and 3.67 per cent to employees' EPF). The total of the employee and employer contribution is deposited in a fund created with the Employee Provident Fund Organization (EPFO). Additionally, if the employee completes 10 years of service, he/she will be eligible for pension under the Employees Pension Scheme (EPS).
- EXAM QUESTIONS: (1) Explain the technical differences between GPF, PPF and EPF. Which one would be best for you and why? (2) What are government's new taxation norms for high volume depositors in EPF? Why?
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