Employer Contributions & Taxable Perquisites Under Section 17(2)

The Income Tax Act, 1961 has specific provisions regarding employer contributions to Provident Funds (PF), pension schemes, and similar funds. If an employer contributes more than ₹7.5 lakhs in a financial year, the excess and the earnings on that excess are treated as a taxable perquisite for the employee.

A perquisite is a benefit or advantage received by an employee from their employer, in addition to their regular salary. Certain perquisites are taxable. In this case, the earnings on employer contributions exceeding ₹7.5 lakhs are considered a taxable perquisite.

Before April 1, 2021, there was no specific mechanism to tax the interest or earnings on employer contributions exceeding ₹7.5 lakhs in recognized provident funds, approved superannuation funds, and the National Pension Scheme. The Finance Act 2020 introduced changes to Section 17(2) of the Income Tax Act to address this. This amendment, effective from Assessment Year 2021-22, aimed to tax the “annual accretion” (earnings) on these excess contributions. Rule 3B was then introduced to provide the calculation method.

The CBDT, through G.S.R. 155(E), introduced the Income-tax (1st Amendment) Rules, 2021, which amended the Income-tax Rules, 1962. These changes focus on defining and computing taxable perquisites under Section 17(2)(viia) of the Income-tax Act, 1961.

Understanding this rule is important for both employers and employees to accurately calculate taxable income and ensure compliance.

This article breaks down how this is calculated, based on Rule 3B of the Income-tax Rules, 1962.

Background and Applicability

• Effective Date: These rules came into force on April 1, 2021, and apply to A.Y 2021-22 onwards.
• Objective: To tax annual accretions (interest, dividends, or similar earnings) in excess of ₹7.5 lakhs contributed by employers to specified funds.

Specified Funds Covered Under the Rule

The rule applies to employer contributions exceeding ₹7.5 lakhs annually to:

1. Recognised Provident Fund (RPF)

2. Approved Superannuation Fund

3. National Pension Scheme

What is Taxed?

• Excess Contributions (Clause vii): Employer contributions beyond ₹7.5 lakhs in a financial year.
• Annual Accretion (Clause viia): Income earned on excess employer contributions, such as:
  • Interest
  • Dividends
  • Other similar earnings

The core of this rule is the following formula:

TP = (PC/2) * R + (PC1 + TP1) * R

Let us break down each component:

• TP (Taxable Perquisite): This is the final amount that will be added to the employee’s income and taxed.
• PC (Principal Contribution – Current Year): This is the employer’s contribution during the current financial year that exceeds ₹7.5 lakhs. Only the amount above ₹7.5 lakhs is considered.
• R (Rate of Return): This represents the effective rate of return earned on the fund during the current year. It is calculated as:

R = I / Favg

• • I (Income Accrued): The total income (interest, dividends, etc.) earned by the fund during the current financial year.
  • Favg (Average Fund Balance): The average of the fund balance at the beginning and end of the current financial year. Calculated as: (Opening Balance + Closing Balance) / 2
• PC1 (Principal Contribution – Previous Years): This is the total of all employer contributions in previous financial years (starting from April 1, 2020) that exceeded ₹7.5 lakhs in those respective years.
• TP1 (Taxable Perquisite – Previous Years): This is the total of the taxable perquisites already calculated in previous financial years (starting from April 1, 2020) under this same rule.

Practical Illustrations for Better Understanding

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