Capping of interest on PF to discourage savings & investment

Capping of interest on PF to disincentivise, demotivate & discourage savings & investment in PF

The Finance Bill 2021 has introduced capping of tax free interest on PF above the contribution of 2.5 lacs in a financial year. In simple words it implies that if an assessee contributes more than Rs. 2.5 lakh in any financial year on or after April 1, 2021 the interest earned on contribution exceeding Rs. 2.5 lacs would not be tax-free and would be subjected to Income-tax at applicable rates. These new provisions would come into effect from April 1, 2021, once they are passed by the parliament.

The proposed capping of interest on contribution of Rs. 2.5 lacs has been done to dissuade the assessees to invest in PF because the rate of interest under PF schemes are higher than the normal bank rates and moreover the interest earned on the PF accounts is totally Tax Free. It would be relevant to reproduce the relevant amendments made in the Finance Bill 2021 which are as under:

”(d) with effect from the 1st day of April, 2022,––

(i) in clause (11), the following proviso shall be inserted, namely:–– 

“Provided that the provisions of this clause shall not apply to the income by way of interest accrued during the previous year in the account of a person to the extent it relates to the amount or the aggregate of amounts of contribution made by that person exceeding two lakh and fifty thousand rupees in any previous year in that fund, on or after the 1st day of April, 2021 and computed in such manner as may be prescribed;

(ii) in clause (12), the following proviso shall be inserted, namely:–– 

“Provided that the provisions of this clause shall not apply to the income by way of interest accrued during the previous year in the account of a person to the extent it relates to the amount or the aggregate of amounts of contribution made by that person exceeding two lakh and fifty thousand rupees in any previous year in that fund, on or after the 1st day of April, 2021 and computed in such  manner as may be prescribed;”.

According to the Memorandum to the Budget, this would prevent high earners from enjoying tax exempt interest by contributing money to PF. “Instances have come to the notice where some employees are contributing huge amounts to these funds and entire interest accrued/received on such contributions is exempt from tax under clause (11) and clause (12) of section 10 of the Act. This exemption without any threshold benefits only those who can contribute a large amount to these funds as their share,” read the Memorandum to the Budget.

Employee and employer contribution under the EPF Act is set at 12% of the salary. However, you can voluntarily contribute more than this amount to VPF, without any upper limit. This created a loophole for highly paid and savvy employees to enjoy tax-free interest. Under the existing provisions interest on EPF, VPF and exempted PF trusts is exempt from tax regardless of the amount of contribution. However, the new tax provisions would thus apply on the interest earned on the contribution and not the contribution itself. The interest accumulated on any PF balance will still remain totally tax-free where contribution during any financial year does not exceed Rs. 2.5 lakh as prescribed by the proposed amendments in Finance Bill 2021.

An important question arises whether an employee contributing Rs. 2 lakh to EPF and Rs. 1.5 lakh to PPF during a year even after April 1, 2021 still enjoy the tax-free status of the interest income?

On a plain reading of the budget documents, it appears that the amendments 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 appears that there are separate limits for EPF/VPF and PPF i.e. contributions to PPF and EPF/VPF will not be aggregated for the purpose of calculating the Rs 2.5 lakh limit.

It is noteworthy that as per the PPF provisions, a person is not allowed to contribute more than Rs 1.5 lakh per financial year to PPF. Thus interest earned on PPF account would not be adversely affected by these proposed amendments. However, in case of EPF and VPF contributions, the total of contributions to both – EPF and VPF- should not exceed Rs 2.5 lakh in a financial year to enjoy tax exemption on the interest earned on EPF and VPF contributions. If an employee’s total contribution to EPF and VPF together exceeds Rs 2.5 lakh in a financial year, then the interest earned on the excess contribution will now be taxable in the hands of an employee as per these amendments brought in the Finance Bill 2021.

Thus it is certain that the amendments brought in the Finance Bill  would apply to both the EPF and the PPF independently to both and would not club both of them. The budget indicates that a new proviso will be introduced in both sections 10 (11) (which deals with the PPF) and 10 (12) (which deals with EPF) of the Income-tax Act,1961. The wording of the amendments in the Finance Bill clearly mandate that the exclusions provided in those sections would apply in relation to amounts contributed “in that fund”. This clearly and unambiguously implies that each of the funds would be treated separately and the intent of the Government is not to aggregate the amounts lying in the PPF together with those accumulated in the EPF and then apply the threshold of 2.5 lakhs. Therefore, if the contribution by an individual in a year to the PPF is 1.5 lakhs while that in the EPF is 3 lakhs, then it would only be the interest on the 50,000 (the excess contributed to the EPF over the 2.5 lakh threshold) which would be considered as taxable income for the employee.

The above provisions are being legislated to check excessive investment in avenues which give rise to exempt income. However, by proposing these amendments by  capping accrued interest on PF contributions, the FM has placed heavy burden on the honest middle class tax payers. The move of taxing interest on PF contributions is being found distasteful & discriminatory particularly by the salaried class. This move would not allow the common man to save even for his retirement. It is pertinent that there is no Social Security provided to assessees even after paying Income Tax whole life. Saving for old age, marriage of children & construction of Home is imbibed in our social system. The move of capping of interest on PF will undoubtedly disincentivise, demotivate & discourage savings & investment in all schemes of PF and create resentment amongst the assessees particularly the salaried middle class.