Taxability of Interest on PF on employee’s contribution w.e.f FY 2021-22

There is a lot of confusion on the issue of taxability of interest on PF (Provident fund) on employee’s contribution in excess of Rs 2,50,000 P.A w.e.f FY 2021-22.

Before going in to that let’s have a relook into the provisions brought by the Finance Bill 2021.

“Taxability of Interest on various funds where income is exempt

Clause (11) of section 10 of the Act provides for exemption with respect to any payment from a provident fund to which the Provident Funds Act, 1925 (19 of 1925) applies or from any other provident fund set up by the Central Government and notified by it in this behalf in the Official Gazette.

Similarly, Clause (12) of this section provides for exemption with respect to the accumulated balance due and becoming payable to an employee participating in a recognised provident fund, to the extent provided in rule 8 of Part A of the Fourth Schedule

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.

Accordingly, it is proposed to insert proviso to clause(11) and clause (12) of section 10 of the 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 contribution made by the person exceeding two lakh and fifty thousand rupees in a previous year in that fund, on or after 1st April, 2021, computed in such manner as may be prescribed.

These amendments will take effect from 1st April, 2022 and shall apply to the assessment year 2022-23 and subsequent assessment years.

[Clause 5]”

From the above it is clear that taxability will be there only for those employees who are contributing Rs 2.50 lacs or more during a financial year in their providend fund account.

We know that PF of any employee consist of contribution from two sources:

1) Employer’s contribution (which is 12% as of now )

2) Employee’s contribution (which is mandatory 12% + VPF (Voluntary providend fund) as per employee discretion).

Employees generally go for VPF (Voluntary providend fund) because of following reasons:

1) It creates forced saving (as the money get deducted from salary itself)

2) It provides a lump sum amount at the time of their retirement and for other needs.

3) It provides higher rate of interest than the market rate of interest

4) It’s a risk free investment.

5) The whole amount of interest is tax free which was otherwise taxable if invested in other deposits.

In order to discourage employees who are enjoying tax free interest on their PF proviso has been inserted in section 10(11) and 10(12), so that taxability of interest on PF becomes at par with interest from other investments.

It may be noted that Finance bill stipulates that manner of computation will be provided.

Till the time manner of computation is provided, confusion arises wrt amount of interest on which tax will be applicable i.e

1) Whether tax will be applicable on whole amount of PF interest (i.e interest on both employer and employee’s contribution including accumulated balance till 31.03.2021)

2) Whether tax will be applicable on whole amount of interest earned on employee’s contribution (i.e accumulated balance till 31.03.2021 + contribution on or after 01.04.2021)

3) Whether tax will be applicable only on the amount of interest earned on employee’s whole contribution on or after 01.04.2021. (i.e no tax on accumulated balance till 31.03.2021)

4) Whether tax will be applicable on the amount of interest earned on employee’s contribution in excess of Rs 2.50 Lacs P.A on or after 01.04.2021.

We can understand the above with the help of following example:

Emplo-yee	Accumulated balance on 31.03.2021 (Rs in Lacs)			Contribution in FY 2021-22 (Rs in Lacs)			Interest earned in FY 2021-22 (Say 8%) (Rs in Lacs)
							Accumulated Balance			Contribution for the year			Total Interest
	Empl-oyer	Empl-oyee	Total	Empl-oyer	Empl-oyee	Total	Empl-oyer	Empl-oyee	Total	Empl-oyer	Empl-oyee	Total
X	15.00	40.00	55.00	1.80	1.80	3.60	1.20	3.20	4.40	0.14	0.14	0.29	4.69
Y	15.00	40.00	55.00	1.80	3.00	4.80	1.20	3.20	4.40	0.14	0.24	0.38	4.78
Z	15.00	40.00	55.00	1.80	6.00	7.80	1.20	3.20	4.40	0.14	0.48	0.62	5.02
P	15.00	40.00	55.00	1.80	2.40	4.20	1.20	3.20	4.40	0.14	0.19	0.34	4.74

We know that trigger point for taxability of interest on PF is annual contribution in excess of Rs 2.50 lacs.

From the above table it is clear that in the case of Mr X, nothing will be taxable on account of interest on PF as his annual contribution w.e.f 01.04.2021 is Rs 1.80 Lacs (i.e below 2.50 Lacs).

Similarly in case of Mr P also nothing will be taxable on account of interest on PF as his annual contribution w.e.f 01.04.2021 is Rs 2.40 Lacs (i.e below 2.50 Lacs).

However in case of Mr Y interest on PF will be taxable since his annual contribution is in excess of Rs 2.50 lacs (i.e Rs 3 Lacs). Now question arises whether tax will be applicable on

1) Whole Rs 4.78 Lacs (i.e interest on total accumulated balance and contribution during the year by both employer and employee), or

2) Rs 3.44 lacs (i.e 3.20+0.24) [i.e interest earned on employee’s contribution (i.e accumulated balance till 31.03.2021 + contribution on or after 01.04.2021]

3) Rs 0.24 Lacs (interest earned on employee’s whole contribution on or after 01.04.2021)

4) Rs 0.04 Lacs [i.e 0.24* (3-2.5)/3] (i.e interest earned on employee’s contribution in excess of Rs 2.50 Lacs P.A on or after 01.04.2021)

Similarly in case of Mr Z interest on PF will be taxable since his annual contribution is in excess of Rs 2.50 lacs (i.e Rs 6 Lacs). Now question arises whether tax will be applicable on

1) Whole Rs 5.02 Lacs (i.e interest on total accumulated balance and contribution during the year by both employer and employee), or

2) Rs 3.68 lacs (i.e 3.20+0.48) [i.e interest earned on employee’s contribution (i.e accumulated balance till 31.03.2021 + contribution on or after 01.04.2021]

3) Rs 0.48 Lacs (interest earned on employee’s whole contribution on or after 01.04.2021)

4) Rs 0.28 Lacs [i.e 0.48* (6-2.5)/6] (i.e interest earned on employee’s contribution in excess of Rs 2.50 Lacs P.A on or after 01.04.2021)

From the text of Finance bill 2021, it appears that taxable interest will be either of 3^rd or 4^th option (i.e in case of Mr Z either Rs 0.48 Lacs or Rs 0.28 Lacs).

Again there is no mention of the taxability of interest on interest accruing on or after 01.04.2021.

The payroll section of the company may find it very difficult to compute interest under 3^rd and 4^th option as they would require to maintain huge database of timing of contribution by each employees.

It is expected that Govt will come with a simple method of computation of taxable interest on PF and at the same time will not cause hardship to those employees whose PF interest becomes taxable because of border line contribution as the situation prevails in case of 87A deduction.

Note: In case of section 87A a deduction of Rs 12500 from tax is given for those individuals whose income is upto Rs 5 lacs. The moment someone earns Rs 5,00,010 no rebate is allowed and for earning additional Rs 10 he is required to pay tax of Rs 12500 + cess of 4%.