Tax on Interest on Employee Contribution to PF over Rs 2.5 Lacs

Taxability of Interest on Employee Contribution to PF over Rs 2.5 Lacs in a Financial Year (New Provision Proposed in Union Budget to be effective from 1st April 2021)

Background of Provident Fund

Employee Provident Fund is the fund the purpose of which is to provide the employee social security for him and his family with the lump sum payments at the time of exit from their employment.

Contribution to EPF is done both by the employee and employer.

The employer deducts employee’s share of EPF contribution from his salary, and a similar amount is contributed by the employer, and both these contributions are deposited in the  PF account of employees.

The present contribution by the employee is 12% of salary ( i.e. Basic Pay + DA (if forming part of retirement benefits) + Commission (if based on % of Sales Turnover)

A similar contribution is made by the employer also but an amount of Rs. 1250 pm * is diverted to Employees’ Pension Scheme (known as EPS -95)   out of contribution by the employer.

*8.33% will be diverted to the Employees’ Pension Scheme, but it is calculated on Rs 15,000 (Maximum). So, for every employee with a salary of Rs 15,000 or more, the diversion is Rs 1,250 pm into EPS. If the salary is less than Rs 15,000 then 8.33% of that actual amount will go into EPS. The balance will be retained in the EPF account.

Example:  Mr. XYZ has a salary of Rs 1,00,000 pm.

His own contribution from the salary will be Rs 12,000 pm ( i.e. 12% of Rs. 100000)

Employer Contribution will also be Rs 12,000 but an amount of Rs 1250 ( i.e. 15,000* 8.33% ) will go to EPS -95 and the rest of the amount Rs. 10,750 ( i.e.  12000- 1250)  will go to employee pf account as a share of employer contribution.

Detailed understanding of different kinds of Provident Funds and Taxation  

There are different kinds of provident funds, they differ from each other in their operation and taxability. They are also governed by a different set of rules. These funds can be Statutory Provident Funds, Recognised Provident Funds, Unrecognised Provident Funds, and  Public Provident Funds.

The Provident Funds are categorized as follows:

1. Statutory Provident Fund  /General Provident Fund (SPF/GPF) – This is set up under the Act of the Parliament i.e., Provident Funds Act, 1925. This fund is maintained by Government/Semi-Government/University/Educational Institutions (affiliated to university) for their employees. The accumulations in this fund are paid to the employee at the time of retirement or superannuation. These funds are not available to the private sector employees.

2. Recognized Provident Fund ( RPF)  – This fund is recognized by the Commissioner of Income-tax according to the rules and provisions contained in the Income-tax Act. A fund that is not approved by the Commissioner of Income Tax is considered an unrecognized provident fund. It may have been recognized by the commissioner of provident fund or any other formal authority, but for a fund to enjoy income tax benefits of a recognized provided fund, it must be approved by a commissioner of income tax. It includes a provident fund established under a scheme framed under the Employees’ Provident Funds Act, 1952. This fund is maintained by private sector organizations.  PSU employees are considered private-sector employees under Income Tax Act.

3. Public Provident Fund ( PPF )– This Fund is an investment and tax-saving instrument for Resident Individuals. The PPF account can be opened in any designated nationalized bank and selected post office branches. The maximum investment in the fund can be made up to Rs.1.5 lacs in a year and interest earned is tax-free.

4. Unrecognized Provident Fund (URPF)– Unrecognized provident fund is that provident fund that is neither a statutory provident fund nor a recognized provident fund and which is also not a public provident fund.

Existing Provision of  taxability of Provident Fund under Income Tax Act,1961

• Section 10(11) of the Income Tax Act, 1961 provides an exemption in respect of the amount received from the public provident fund and /statutory provident fund
• Section 10(12) of Income Tax Act, 1961 provides an exemption in respect of amount received from recognized provident fund

Taxability  at different stages   

The issue of taxability in respect of these funds arises at the time of

• Paying contributions into the fund,
• Deduction u/s 80C on employee contribution
• Interest earned on the fund.
• Receiving the matured amount from the fund and

The taxability at each of the stage is discussed as under:

Particulars	SPF	PPF	RPF	URPF
Employer’s Contribution	Not treated as Income. Fully Exempt.	N.A.	Employer contribution up to 12% of Salary is exempt. Over 12%, taxable in the hands of the employee. But the Government has further put a combined cap of Rs 7,50,000 3 retirement funds of the employee ( i.e. Recognized Provident Fund, Superannuation Fund, and NPS ). This means if an Employer Contribution in all  3 specified funds during the previous financial year exceeds Rs. 7,50,000, it will be taxable in hands of employees  [Vide Clause vii of section 17(2)].	Not treated as Income. Fully Exempt.
Employee’s Contribution	Deduction u/s 80C available	Deductionu/s  80C available	Deduction u/s 80C available	Not eligible for deduction u/s 80C
Interest Credited	Fully Exempt	Fully Exempt	Exempt from tax to the extent rate of interest does not exceed the notified rate; interest over the notified rate is taxable	Fully Exempt
Amount received on retirement, death, etc.	Fully exempt u/s 10(11)	Fully exempt u/s 10(11)	Fully exempt subject to conditions u/s 10(12)	See Note

Note: Termination payment will include 4 things, viz., employee’s contribution and interest thereon and employer contribution and interest thereon. The tax treatment of such payments are as follows:

• Employee’s contribution is not chargeable to tax; interest on employee contribution is taxed under the head “Income from other sources”.
• Employer’s contribution and interest thereon are taxed as salary income u/s 17(3) of Income Tax Act.  However, an employee can claim relief u/s 89 in respect of arrears of such payment.

Proposed Amendment to be effective from 1st April 2021

The Finance Bill 2021 proposes to insert a proviso to Sections 10(11) and 10(12) of Income Tax Act – “providing that the provisions of these clauses shall not apply to the interest income accrued during the previous year in the account of the person to the extent it relates to the amount or the aggregate of amounts of the contribution made by the person exceeding Rs. 2, 50,000 in a previous year on or after the 1st day of April 2021 and computed in such manner as may be prescribed”

It means that no exemption shall be available for the interest income accrued during the previous year in the recognized and statutory provident fund to the extent it relates to the contribution made by the employees over Rs. 2, 50,000 in the previous year.

Salient Features of the Proposed Amendment:-

• This taxability of interest shall be applicable only for the contribution made on or after April 1, 2021.
• The Finance bill stipulates that a manner of computation of interest will be provided.
• The Provision is applicable for employee’s contribution only. The employer’s contribution is not covered in this provision.
• The interest earned on employers’ contribution and employer’s contribution till 31st March 2021 is not covered under this provision and not taxable.
• The interest income earned on excess contribution will be taxable only in those cases where the employees’ annual PF contribution to PF exceeds Rs. 2.5 lacs.
• The Union budget has proposed to levy income tax on interest earned by an employee/person on his/her contribution over Rs 2.5 lakh in a financial year. On a plain reading of the budget documents, it appears that tax will apply to the interest earned on contributions made to Employees’ Provident Fund (EPF), Voluntary Provident Fund (VPF) as well as Public Provident Fund (PPF). However, it is clarified that there are separate limits for EPF/VPF and PPF. The contribution to PPF is currently has a restriction of  Rs. 1.5 lakhs p.a. so this amendment will not have any impact on PPF contribution.

How the Interest on Provident Fund will be calculated   

First, the formal rules on computation are yet to be issued by the Govt. But initial indications are that taxpayers would need to add the interest accrued every year to their Income Tax Statements. The interest portion is calculable on a year-to-year basis, and that will go on an accrual basis so that it is taxable on your computation of income in that year.

Feature

• It will work exactly in the same manner as the way interest income on bank fixed deposits is taxed today.
• Such interest component shall be subject to TDS under Section 194A of the Income Tax act by the EPFO. However, prescribed rules are awaited in this regard.
• The interest income accruing in respect of the employee’s contribution over Rs. 2.5 lacs shall be taxable under the head ‘Income from other sources as it is provided from the Trust / EPFO and not accruing from an employer-employee relationship.
• A cap of Rs 2.5 lakhs applies independently to PPF contribution and EPF/VPF. At present contribution to PPF is already has a restriction of Rs 1.5 lacs so this amendment will not have any impact on PPF contribution.

Illustration showing interest calculation and TDS thereon

Mr. XYZ has an annual salary (Basic + DA) of Rs 25 Lacs.

His contribution to PF is 12% in the FY 2021-22.

Assuming the rate of interest on EPF is 8.5% per annum

His tax liability will be calculated in the following manner: –

His Contribution in the Fund = 25 Lacs *12%=Rs 3 Lacs

Excess contribution (Rs.3Lacs-2.50Lacs) = Rs.50,000

Interest on excess contribution = Rs.50,000*8.5%=Rs 4250

This amount of Rs. 4250 will be added to the employee’s taxable income and taxed according to his tax slab.

Fixed deposit interest is treated as ‘Income from other sources’ and TDS @10% is deducted on the interest before it is credited (unless you fall in the exempt category). This is likely to be the case with interest on excess PF contribution too. The procedure would be clear only after the CBDT officially notify the rules.

In the above example TDS @ 10% under section 194 A would be Rs 425 and the same would be reflected in his Form 26AS as TDS deducted.

Note :

1.Limit of Employee contribution to PF includes VPF also

2.An employee whose salary is around Rs 23.50 Lacs and not contributing to VPF will not be impacted by this provision.

FAQs

1. Will the cap includes employer contribution to PF also, apart from employee PF/ VPF     contribution?

Rs 2.5 lakh cap is for employee contribution (including VPF)  only. It does not include the employer’s contribution.

2. How will the interest earned on my PF contributions over Rs 2.5 lakh be taxed?  Whether TDS will also be deducted :

First, the formal rules on computation are yet to be issued by the Govt. But initial indications are that taxpayers would need to add the interest accrued every year to their income-tax Statements. Central Board of Direct Taxes (CBDT) chairman Mr. PC Mody has indicated that the interest on excess PF contribution will be taxed like that of bank fixed deposit interest. The interest portion is calculable on a year-to-year basis, and that will go on an accrual basis so that it is taxable on your computation of income in that year.

Manner of interest calculation and TDS calculation is already given in the above Illustration.

3. In the above illustration will Rs.4250 (interest on additional contribution) will be considered as a new investment and should be part of Rs. 2.5 Lac limit?

Clarification is expected in this regard from the Government.

4. How will taxability be calculated for FY 22-23 for:

i. Interest earned on contribution already made in 21-22

ii. Interest on the contribution made in 22-23

Logically, for FY 22-23, the tax should not be on the contribution made in FY 21-22 as the same would have already been taxed in FY 21- 22. However, clarification is awaited from the Govt.

5. What would be the taxability of interest earned from 1st April 2021 on old contributions made till 31st March 2021?

Contribution till 31st March 2021 would not be subject to tax

6. Whether contribution made by the employee in the PF account during the month March 2021 to be included in the limit of Rs 2.5 lakh.

The new provision says that the interest accrued on the contribution to PF on or after 1st April 2021 to the extent it exceeds Rs 2.5 lacs in a financial year will not be exempted.

The deduction made towards PF from the salary of an employee of a particular month is deposited in the provident fund account in the next month. Therefore, the PF deduction made from the salary of Mar 2021 will be deposited in the employee provident fund account in the month of April 2021, so it appears that such contribution will be counted in calculating the limit of  Rs 2.5 lacs.

7. Whether PPF contribution is also to be included in the limit of Rs 2.5 Lacs?

No. There is a separate limit for PF and PPF. Therefore contribution to PPF will not be aggregated in the limit of Rs 2.5 Lacs.

8. Whether for every successive year the interest on that excess contribution will be taxable or it means only the first year the interest is taxable?

Clarification is expected from the Govt.

9. What are the other options to invest if this provision is passed /approved by the Finance Act 2021?

After such amendment, the tax return from PF would be only around 5% (assuming Tax slab of 30%). Of course, there are several other investment options available in the market that offer a higher return of more than 5% (after-tax) and also offer better liquidity.

Conclusion:

The provision is not yet passed in the parliament, eveng if the same is passed :

i. It is expected that Govt will come with a simple method of computation of taxable interest.

ii. We need not worry there are several other investment alternatives available in the market that offer a return higher than the tax-free return in the Provident Fund.