1. The Union Budget 2021 has proposed taxing the income on provident fund contributions of over Rs. 2.5 lakh a year. As per clause 5 of Finance Bill 2021, the interest on any contribution above Rs 2.5 lakh by an employee to a recognized provident fund will be taxable from 01 April 2021.
2. Existing Statutory Provisions Section 10(11) and 10(12) of the Income Tax Act provides an exemption for the statutory provident fund and recognized provident fund respectively. Interest credited every year in the Employee provident fund account (EPF) is exempt from tax. The deposits in EPF fall under the Exempt, Exempt, Exempt (EEE) tax category. Thus, an employee is not liable to pay tax at all three levels – investment, earning, and withdrawal
3. Proposed Amendment: The Finance Bill 2021 proposes to insert Proviso to Sections 10(11) and 10(12) – “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”
3.1 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.
4. Reason for the Amendment: This amendment has been proposed as the Government noticed that some employees have been contributing a huge amount to these funds. The interest rate on EPF is generally higher than other small savings schemes and fixed deposits that offer guaranteed returns. The higher interest rate on EPF prompts employees to put higher corpus in EPF, which in turn makes it difficult for the government to pay interest on the same.
5. Salient Features of the Proposed Amendment:-
(a) This interest taxability shall be applicable only for the contribution made on or after April 1, 2021.
(b) The employee’s principal contribution, employer’s contribution, entire interest earned on employers’ contribution, and interest earned by the employee till 31st March 2021 are not taxable
(c) The interest income earned on excess contribution will be taxable only in those cases where the employees’ annual PF contribution exceeds Rs. 2, 50,000/-.
(d) The contribution to PPF is already restricted to Rs. 1.5 lakhs p.a. currently, so this amendment will not have any impact on PPF contribution.”
6. Manner to tax the Interest:
There would be no double taxation and 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 194(a) 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, 50,000 shall be taxable under the head ‘Income from other sources’ as it is not accruing from a source emanating from an employer-employee relationship.
This interest income will become part of the total taxable income of the taxpayer. There are no special rates for the taxability of this interest. Hence, such income shall be taxed at the prevailing income tax rates.
7. Illustration Mr. X’s total contribution (including voluntary provident fund) to Employee Provident Fund (EPF) is Rs 3, 50,000 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:-
|Financial Year||Employee’s contribution in EPF in a year
|Contribution liable for tax on interest (b- 2,50,000)||Interest on the excess contribution
|TDS @ 10% under section 194 A
(10% on d)
|Balance taxable amount to be added in taxable salary (d-e)|
In the illustration above, Rs. 8500/- will be added to the employee’s taxable income and tax will be payable by him according to his tax slab. Rs. 850/- will be reflected in his form 26AS as TDS deducted. In case, his tax slab is less than 10%, he will be eligible for a refund of Rs 850/- deducted by the EPFO as TDS.
8. Public Provident Fund (PPF):- A cap of Rs 2.5 lakhs is applicable independently to PPF contribution for claiming interest on PPF. At present, this is not relevant because of the Rs.1.5 lakh limit on contribution to PPF itself. Thus this amendment will not have any impact on PPF contribution.
Disclaimer: The article is for information purposes only.
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