Tax on income out of excess employer contribution to specified funds – Computation methodology prescribed

The Finance Act 2020 introduced a new provision under the Income-tax Act, 1961 (the Act) by virtue of which employer contribution exceeding Rs. 7.5 lakhs p.a. (i.e. excess contribution) in aggregate to the following funds is now taxable in the hands of the employee as perquisite:

  • Employer contribution in a recognized provident fund;
  • Employer contribution in National Pension Scheme (‘NPS’);
  • Employer contribution in an approved superannuation fund.

(Above funds shall be collectively referred to as ‘Specified funds’ in this article)

Further, the annual accretion by way of interest, dividend etc. to the specified funds attributable to such excess employer contribution is also a taxable perquisite. While the excess employer contribution above Rs. 7.5 lakhs p.a. is taxable u/s 17(2)(vii), the annual accretion attributable to such excess contribution is taxable u/s 17(2)(viia). These provisions are applicable from FY 2020-21 (AY 2021-22) onwards. The focus of this article would be to throw some light on the new rule prescribed to tax annual accretion u/s 17(2)(viia).

Earlier, employer contribution to specified funds was taxable only if the contribution exceeded certain limits provided under the Act for a particular fund. However there was no upper limit for all specified funds combined which as per the Government gave undue tax benefit to employees in high salary bracket designing their salary structure in such a way so as to maximize tax benefit by way of higher employer contributions to specified funds.

The Central Board of Direct Taxes (‘CBDT’) vide notification G.S.R. 155(E) [NO. 11/2021/F. NO. 370142/52/2020-TPL], DATED 5-3-2021 has inserted a new Rule 3B in the Income-tax Rules, 1962 (“the Rules”). This rule provides detailed computation mechanism to calculate the annual accretion to the specified funds taxable u/s 17(2)(viia).

Rule 3B provides the below formula to calculate the taxable perquisite u/s 17(2)(viia):

“TP= (PC/2)*R + (PC1+ TP1)*R

Where,

TP= Taxable perquisite under u/s 17(2)(viia) of the Act for the current previous year;

TP1 = Aggregate of taxable perquisite u/s 17(2)(viia) of the Act for the previous year or years commencing on or after 1st day April, 2020 other than the current previous year (See Note);

PC= Amount or aggregate of amounts of principal contribution made by the employer in excess of Rs. 7.5 lakh to the specified fund or scheme during the previous year;

PC1= Amount or aggregate of amounts of principal contribution made by the employer in excess of Rs. 7.5 lakh to the specified fund or scheme for the previous year or years commencing on or after 1st day April, 2020 other than the current previous year (See Note);

R= I/Favg ;

I=Amount or aggregate of amounts of income accrued during the current previous year in the specified fund or scheme account;

Favg = (Amount or aggregate of amounts of balance to the credit of the specified fund or scheme on the first day of the current previous Year + Amount or aggregate of amounts of balance to the credit of the specified fund or scheme on the last day of the current previous year)/2.

Note: Where the amount or aggregate of amounts of TP1 and PC1 exceeds the amount or aggregate of amounts of balance to the credit of the specified fund or scheme on the first day of the current previous year, then the amount in excess of the amount or aggregate of amounts of the said balance shall be ignored for the purpose of computing the amount or aggregate of amounts of TP1 and PC1.”.

The above mechanism appears somewhat complicated. However, I have tried to explain the same by way of an example as below:

Particulars FY 2020-21 FY 2021-22 FY 2022-23 FY 2023-24 FY 2024-25
Opening balance of specified funds (A)      50,00,000        64,40,000      82,03,200       91,19,200        4,88,700
Employer contribution during the year (B)      10,00,000        12,00,000        2,50,000                     –                    –
Withdrawal during the year (C)                    –   (90,00,000)
Annual accretion during the year (interest etc.) (D)        4,40,000           5,63,200        6,66,000         3,69,500            39,100
Closing balance of specified funds (E)= (A+B-C+D)     64,40,000        82,03,200      91,19,200         4,88,700        5,27,800
Taxable perquisite (‘TP’) u/s 17(2)(viia) by applying Rule 3B
Formula: TP = (PC/2)*R + (PC1+ TP1)*R
PC = (B) minus 7,50,000; or 0, whichever is higher        2,50,000           4,50,000                    –                    –                   –
I = (D)        4,40,000           5,63,200        6,66,000         3,69,500            39,100
Favg = (A + E)/2      57,20,000        73,21,600      86,61,200       48,03,950        5,08,250
R = I/Favg 7.69% 7.69% 7.69% 7.69% 7.69%
PC1 (Aggregate PCs of all earlier years)                    –           2,50,000        7,00,000         7,00,000        7,00,000
TP1 (Aggregate TPs of all earlier years)                    –                9,615            46,893         1,04,326        1,66,191
Excess of TP1+PC1 over Opening balance(A) –                    –                    –                    –                   –        3,77,491
TP = (PC/2)*R + (PC1+ TP1)*R           

9,615

             37,278            57,432            61,865            37,596*
Perquisite u/s 17(2)(vii) = PC 2,50,000 4,50,000 0 0 0
Total taxable perquisite 2,59,615 4,87,278 57,432 61,865 37,596

(Notes:

1. To calculate annual accretion at (D), I have used interest rate of 8% on opening balance and 4% on contribution/withdrawal during the year on the assumption that contribution/withdrawals have been made uniformly during the year

2. Minor differences may arise due to interest rate rounding off

3. *When due to withdrawal, PC1+TP1 exceed the opening balance of the fund, taxable interest is calculated on the opening balance of the fund as the excess of PC1+TP1 over the opening balance is ignored)

Some key takeaways from the newly prescribed Rule 3B:

  • Any interest/other accretion earned on excess contribution during any year will be taxed in perpetuity;
  • Even the interest on interest earned in future years due to any excess contribution in any year will be taxable;
  • There is a possibility of difference in actual interest earned annually on specified funds vis-à-vis the taxable interest due to difference in methodology of calculation. For example, interest on some funds is calculated on monthly closing balances, however under Rule 3B the interest rate to calculate tax perquisite is based on the annual opening and closing balance of the specified funds. The variance between the two interest rates will be amplified when the contributions/ withdrawals are greatly skewed towards the beginning or the end of the year;
  • Taxpayers may be at a great disadvantage if the employer contributions exceeding Rs. 7.5 lakhs are made in the later part of the year as the tax perquisite may be much greater than actual interest earned on such excess contributions;
  • In the event of withdrawal from the fund/s, all aggregate annual excess contributions (PC1) irrespective of the years in which such excess contributions were made will form part of the opening balance for the purpose of calculation of perquisite u/s 17(2)(viia). However, if such excess contributions exceed the opening balance the same shall be ignored. Hence, FIFO method is not followed while computing base amounts;
  • Similar computation methodology can be expected to arrive at the tax on interest arising out of Employee’s contribution to PF exceeding Rs. 2.5 lakhs per annum, the provisions for which were introduced vide Finance Bill 2021.

Author’s note:

As soon as the provision was introduced in Budget 2020, there was great anxiety amongst the employees particularly those earning high salary income.

Given the computation method prescribed by the CBDT, the need to revisit salary structure becomes paramount considering the perpetual tax impact on any excess contribution made during any of the years. In other words, any excess employer above Rs. 7.5 lakhs made during Year 1 will continue to pinch the pockets of the taxpayers till Year X or unless the entire balances from the specified funds are withdrawn.

Also, timing of contribution in these funds during the year will have a great impact on the difference of actual interest earned vs the taxable interest. Surely, no one likes to pay taxes on a higher income than what he/she actually earns!

Author Bio

Qualification: CA in Job / Business
Company: N/A
Location: Vadodara, Gujarat, India
Member Since: 11 Mar 2021 | Total Posts: 1

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