Taxation of Employee Provident Fund
Until recently, the Provident fund (PF) contributed, and interest thereon was out of tax ambit. However, recent changes to the income tax laws in India have proposed to tax the PF contributions and interest income over certain limits. This blog summarizes the taxation aspects relating to PF, including:
1. Taxation of PF at the time investment by employee and employer.
2. Taxation on interest earned on PF money. On both balances – employee’s and employer’s contribution.
3. Taxation of PF at the time of withdrawal.
Let’s analyze in detail.
Part A: Table 1: Summary of PF taxation:
Particulars of event | Employer’s Contribution | Employee’s Contribution |
Contribution to PF | As per Union Budget 2020, employer’s contribution to Provident Fund, National Pension Scheme (NPS) and Superannuation Fund more than Rs.7.5 lakh will be taxable as perquisites in the hands of the employee. | Exepmt |
Interest on PF | Refer notes below and Part B for illustration | As per Union Budget 2021, the interest earned on the Employees’ Provident Fund (EPF) account as relatable to contributions more than Rs.2.50 lakh will be taxable. For example if you contributed Rs. 3 lacs to EPF account, interest earned on 50,000 will be taxable. |
Withdrawal of PF (Before 5 years of continuous service) | Employer’s contribution and interest on it is fully taxable. Employer’s contribution is taxed under the head salary in your tax return. Interest is taxed under income from other sources. When TDS is deducted on it, you are likely to see an entry under salary TDS in your Form 26AS for it. | 1. Deduction u/s 80C availed at the time of investment- Taxable as Income from Salary. If Deduction u/s 80C not availed at the time of investment- Not Taxable 2. The Interest portion will be taxed as income from other sources. |
Withdrawal of PF (After 5 years of continuous service) | Exempt | Exempt |
Notes:
Interest taxability shall be applicable only for the contribution made on or after April 1, 2021. If you have accumulated balance before 1st April 2021, interest thereof will not be taxable.
Interest earned by the employee till 31st March 2021 are not taxable.
The newly inserted Rule 9D has specified that separate accounts within the PF Accounts shall be maintained clearing segregating the taxable and non-taxable contributions to PF along with interest thereon.
a. Non-taxable Contribution Account
b. Taxable Contribution Account
Part B: Illustrations:
I. Calculation of taxable portion of Interest on PF – relating to fund contributed by employee:
Month | Monthly Employee Contribution | Balance at the end of each month (Cumulative) | Interest @ 8.5% (illustrative rate) | Non-Taxable | Taxable |
April 21 | 30,000 | 30,000 | 213 | 213 | 0 |
May 21 | 30,000 | 60,000 | 425 | 425 | 0 |
June 21 | 30,000 | 90,000 | 638 | 638 | 0 |
July 21 | 30,000 | 1,20,000 | 850 | 850 | 0 |
Aug 21 | 30,000 | 1,50,000 | 1,063 | 1,063 | 0 |
Sep 21 | 30,000 | 1,80,000 | 1,275 | 1,275 | 0 |
Oct 21 | 30,000 | 2,10,000 | 1,488 | 1,488 | 0 |
Nov 21 | 30,000 | 2,40,000 | 1,700 | 1,700 | 0 |
| 30,000 | 2,50,000 | 1,771 | 1,771 | 0 |
Dec -21 (This months contribution is split in two parts) | | 2,70,000 | 142 | 0 | 142 |
Jan 22 | 30,000 | 3,00,000 | 2,125 | 1,771 | 354 |
Feb 22 | 30,000 | 3,30,000 | 2,338 | 1,771 | 567 |
Mar 22 | 30,000 | 3,60,000 | 2,550 | 1,771 | 779 |
Total | 3,60,000 | | 16,578 | 14,736 | 1,842 |
II. Summary of above:
Sr.No. | Particulars | Total | Non-taxable Account | Taxable Account |
1 | Opening Balance as of 01 Apr 2021 | 50,00,000 | 50,00,000 | - |
2 | Contribution made up to threshold limit / excess of limit in 2021-22 | 3,60,000 | 2,50,000 | 1,10,000 (Exceeding 2.50 lacs is taxable) |
3 | Interest accrued on the amount within threshold / above threshold limit | 16,578 | 14,736 | 1,842 |
| Closing Balance as on 31 Mar 2022 | - | 52,64,736 | 1,11,842 |
III. Calculation of taxable portion of Interest on PF – relating to fund contributed by employer:
As the Employer’s contribution above Rs. 7.5 Lakhs will be taxable, the interest on such excess contribution is taxable us 17(2) (viia) as per Rule 3B.
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
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
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.
Example:
Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
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 |
IV. Taxable Perquisite TP = (PC/2)*R + (PC1+TP1)*R
Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
PC=(B)-7,50,000 or 0 whichever is high | 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 | - | - | - |
Total taxable perquisite | 2,59,615 | 4,87,278 | 57,432 | 61,865 | 37,596 |
Note:
To calculate annual accretion at (D), we 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.
V. Notes on Withdrawal of PF:
If you withdraw from EPF before completing 5 years of continuous service, TDS will be deducted. In calculating 5 years of service, your tenure with the previous employer is also included.
When you change jobs, try not to withdraw the EPF amount, instead you can continue the same account with new company.
If withdrawal amount is less than Rs 50,000, no TDS is deducted.
Withdrawal of EPF (both Employer’s and Employee’s contribution and Interest on it) after 5 years of continuous service: No TDS. Further, the individual need not offer the same in the return of income as such withdrawal is exempt from tax
The EPFO in line with the newly inserted Rule 9D shall provide separate account statements within the PF Accounts. The EPFO will maintain the taxable and non-taxable contributions to PF along with interest thereon. This might make the PF taxation more streamlined.
Taxation of NPS
The National Pension Scheme is a voluntary retirement scheme introduced by the Central Government. Similar to Employee Provident Fund, the contribution made by employer to the NPS account will become taxable if the total amount of PF, Superannuation and NPS exceeds Rs. 7,50,000 in a year.
Employee's own contribution to NPS will not be taxable in any case. This is simply because employee will be making contribution to NPS from tax paid money.
Further withdrawal from NPS is permitted in very specific manner. Please read below:
One can invest in such NPS account regularly and receive 60% of it as a lump sum amount on attainment of 60 years of age and the remaining as annuity pension. If one withdraws in excess of 60% of NPS balance, such excess withdrawal will become taxable in the hands of taxpayer as regular income.
However, the scheme also allows partial withdrawal from the NPS account before attaining the age of 60.
Withdrawal from NPS:
There are two types of NPS accounts- Tier I and Tier II. If you wish to subscribe to NPS it is mandatory for you to open a Tier-I account. Tier-II is an add-on voluntary savings account to a Tier-I account holder with flexible rules. There are no such restrictions on withdrawals from Tier-II accounts. Also, there is no tax benefit on the contributions made to Tier-II account except in case of a central government employee. Partial withdrawal from a Tier-I account is possible under certain circumstances.
Withdrawal terms and conditions
Partial withdrawal from a Tier-I account is allowed only under following circumstances:
Higher education of children;
Marriage of children;
Purchase or construction of residential house or flat in own name or in joint name with the spouse;
Treatment of specified illnesses;
Setting up a new venture or start-up; or
Meeting expenses for skill development, reskilling or self-development activities.
Further:
A maximum of 3 withdrawals are permitted during the entire tenure, i.e. date of joining till 60 years of age;
You must have been in the National Pension System for at least three years from the date of joining; and
Maximum withdrawal of 25% of the contributions made by you is permitted. If your employer has also made contributions to your NPS account, note that only a maximum of 25% of your share of contributions can be withdrawn.
There must be gap of at least 5 years between 2 withdrawals.
Tax Treatment on partial withdrawal from NPS
25% of the permissible withdrawal from the NPS account is tax-free if above conditions are fulfilled.
Withdrawal in contradiction to above conditions will lead to such withdrawal getting added to taxable income.
What are specified illness?
The Pension Fund Regulatory and Development Authority (PFRDA) has specified the following as specified illnesses:
Cancer
Kidney failure
Primary Pulmonary arterial Hypertension
Multiple Sclerosis
Major Organ Transplant
Coma
Myocardial infarction
Stroke
Heart Valve surgery
Aorta Graft Surgery
Paralysis
Serious Life-threatening accidents
Coronary Artery Bypass Graft
Total blindness
Covid-19
Any other illness specified by PFRDA, which critical in nature and life threatening.
Thus one should plan the investments and withdrawal from PF and NPS after thoroughly considering the rate of return, lock in period, withdrawal terms and internal rate of return. There is no such rule as to which is better when comparing PF and NPS. Both carries separate sets of advantages and disadvantages which will affect an individual's decision making.
-Compiled by- Amruta Sohani
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