The Public Provident Fund is savings-cum-tax-saving instrument in India, introduced by the National Savings Institute of the Ministry of Finance in 1968. PPF offers an investment avenue which provides decent risk free returns coupled with income tax benefits under 80C of Income Tax Act.
There are many features which make PPF an attractive investment vehicle for many a people right from getting deduction under 80C to being one of the safe instrument for providing long term wealth. Many of these features are often talked about and discussed but two things which are talked about in parts but not as a whole are why PPF is termed as EEE kind of investment and how effective rate of return one gets from PPF may be much higher because of it being an Exempt, Exempt, Exempt kind of investment. So this article will discuss only these two salient features of PPF.
Why PPF is termed as EEE
Before going into why PPF is termed as EEE, first lets have a little introduction on what exactly EEE is.
There are 3 ways Govt. taxes the monies invested by public at various stages of investment.
Where as the invested amount goes through three stages, which are –
How does EEE relate to these stages?
EEE stands for Exempt, Exempt, Exempt which means –
With this information about EEE we can easily see why PPF is termed as EEE?
PPF is termed as EEE (i.e. Exempt, Exempt, Exempt) because
With this information under our belt let’s see how effective rate of return on PPF may be much higher than the actual rate of interest which is 8.7% (as per the current fiscal year).
Effective rate of return on PPF
Though the rate of interest we get on PPF is 8.7% but as mentioned here the PPF comes under Exempt, Exempt and Exempt investment category so the effective rate of return on PPF can be much higher depending on the tax slab a person comes under.
Current tax slabs are 10%, 20% and 30%. Along with the education cess, which is 3% of the total of Income Tax and Surcharge, the tax rates come to 10.3%, 20.6% and 30.9%. Noting the point that the person doesn’t need to pay any tax on the interest earned on PPF the effective rate of return can go as high as 12.59% if the person happens to fall under 30.9% tax slab.
To show it with the help of an example let us assume that person A comes under 30.9% tax slab as his taxable income is more than Rs. 10,00,000. If he has invested Rs. 1,00,000 in PPF then he earns Rs. 8,700 at the rate of 8.7%. Now if that return is not exempted but taxed then he has to pay 30.9% tax on this interest income of 8,700. In that scenario, when he has to pay tax at 30.9% on interest income, he will have to earn an interest income of Rs. 12,590 to have a post-tax return of Rs. 8,700.
Let’s do the maths!
If interest income is Rs. 12,590 which is taxed at the rate of 30.9%, the tax payable would be
12,590 x 30.9/100 = 3,890.31
If we subtract that tax amount from the interest earned then we’ll get the actual amount
12,590 – 3,890.31 = 8,699.69
The same thing can also be understood in a different way, if one hadn’t shown the investment of Rs. 1 Lakh then one would have paid taxes at 30.9% (assuming the person falls in 30.9% tax bracket) on that Rs. 1 Lakh. So in a way one is investing only Rs. 69,100 to get an interest of Rs. 8,700.
Let’s do the math again –
Amount of tax if that 1 Lakh was not invested
1,00,000 * 30.9/100 = 30,900
Thus actual investment is
1,00,000 – 30900 = 69,100
To get return of Rs. 8,700 on the invested amount of Rs. 69,100 the rate of return should be 12.59%.
69,100 x 12.59/100 = 8699.69
By this calculation again the effective rate of return for a person who comes under the 20.6 % slab is 10.96% and for a person who comes under the 10.2% slab it is 9.69%.
Thus PPF, apart from being a safe investment avenue and having almost zero volatility can provide up-to 12.59% effective rate of return for tax payers. PPF being EEE category investment brings a huge benefit of not to pay any taxes on the invested amount at any of the three stages.