New Delhi: The Finance Bill 2021 passed by the Parliament this week brings relief to those taxpayers who invest in provident funds to save taxes, particularly for those salaried class taxpayers where the employer does not contribute to the corpus.
The bill, which was approved by the Lok Sabha on March 23 and by the Rajya Sabha by a voice vote a day later, proposes to tax the interest earned on the excess contribution made by a depositor over the annual ceiling of Rs 2.5 lakh.
The new rules will be applicable on the PF deposits made on or after April 1, 2021.
The change was necessitated as the government received reports that some taxpayers were parking crores of rupees in provident funds to avoid payment of taxes on the interest earned on their PF deposits, which was against the principles of the scheme as it aims to provide social security to taxpayers by encouraging investment in provident funds by offering tax concessions.
“Earlier there was no tax on the interest earned on the provident fund deposits. And this exemption covered the interest earned on the contributions made by both the employee and employer,” said a tax expert.
He, however, said that the provision was used by some taxpayers to park large amounts in provident funds to avoid paying taxes on the interest earned on their PF deposits as the interest earned, even in crores of rupees, was completely exempt from the income tax.
Rich people availed tax exemptions
According to an analysis conducted by the revenue department earlier this year, there were 1.2 lakh high net-worth (HNI) individuals that contributed huge sums to the provident funds, the highest deposit being Rs 103 crores followed by the second highest deposit at Rs 86 crores.
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According to the data, top 20 PF depositors in the country had a total deposit of Rs 825 crores and top 100 had a balance of Rs 2,000 crores.
For example, a high net-worth individual having a PF deposit of Rs 100 crore will earn interest income of Rs 8.5 crore in both FY 2019-20 and 2020-21 as the rate of interest was 8.5% for these two years. Under the earlier provision, he, however, will not pay any tax on this interest income of over Rs 8.5 crore as it was completely exempt from the purview of income tax.
Govt moves to plug the loophole
In order to plug this loophole, finance minister Nirmala Sitharaman proposed changes in the budget for FY 2021-22, which will tax the interest earned on excess contribution made by an employee over the limit of Rs 2.5 lakh in a financial year.
Interest on employer’s PF contribution remains exempt
Though the government has imposed tax on the excess contribution made by the employee but it would still not tax the interest earned on the contribution made by the employer.
Under the EPF Laws, both employee and employer are required to contribute to provident fund deposits for ensuring social security of an employee. Under the law, an employer is required to contribute a matching amount as per the salary structure of the employee.
The government’s decision to restrict the tax exemption on the interest earned on an employee’s PF contribution upto Rs 2.5 lakh in a financial year allowed a salaried taxpayer not to pay any tax on the interest earned on the PF deposits of Rs 5 lakh and more. As the interest earned on an employer’s matching contribution is still exempt from the tax, which could be Rs 2.5 lakh, it could be more or less also, according to the way salary is structured.
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However, it created an anomaly in tax rules as in some cases, the employer does not contribute any amount to an employee’s provident fund deposits, particularly in those cases in which the government pays pension rather than depositing a matching contribution in an employee’s provident fund account.
New rules protect defence personnel
In order to correct this anomaly, the finance minister Nirmala Sitharaman moved the amendments in the second part of the budget session which concluded on Thursday to exempt such salaried taxpayers. Sitharaman proposed that in such cases where the employer does not contribute to the provident fund of an employee, the interest earned on Rs 5 lakh PF deposit in a year will be tax free.
It will be particularly beneficial for those taxpayers who invest in the Defence Services Officers Provident Fund (the DSOP Fund) or in the Armed Forces Personnel Provident Fund (the AFPP Fund) as these two are non-contributory provident funds, which means no contributions is made by the employer (army, navy or air force) in these accounts.
These provident funds are funded purely by the contributions from the salary received by a service member after paying all applicable personal income taxes.
This amendment will also benefit those central and state government employees who entered the service before 2004 when the government introduced compulsory national pension scheme (NPS) to provide social security post retirement and discontinued the pension.
These central and state government employees invest in the General Provident Fund (GPF) rather than in Employees Provident Fund (EPF).
New changes disappoint others
The amendments to protect the interest of those employees where the employer does not contribute to an employee’s PF account put another category of employees at a disadvantage where the employer’s matching contribution is limited to the statutory requirement of Rs 15,000 in a month, which works out to be Rs 1800 per month.
The employees under this category, even if their own contribution in PF account is Rs 2.5 lakh or more in a year will be eligible to get tax exemption on the interest earned on a total amount of Rs 2,71,600 (Rs 2.5 lakh own contribution and Rs 21,600 employer’s contribution calculated on Rs 1800 per month basis).
Whereas defence personnel, members of armed forces and some other central and state government employees who invest in general provident fund (GPF) will be eligible to avail tax exemption on the interest earned on a PF deposit of Rs 5 lakh in a year.
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