Simply Put: Where the tax on Provident Fund pinches, and how

What is the EPF, and why does the salaried class consider it a reliable social security net? Why does the government want to take it out of the EEE category and make it EET? What is the government’s rationale for making the change?

Written by Sandeep Singh | Updated: March 2, 2016 7:41 pm
taxmn The Employees’ Provident Fund is a retirement benefit scheme that was structured to provide financial security to employees of factories and other establishments post-retirement.

What is the Employees’ Provident Fund (EPF)? Why have governments insisted that salaried employees put a portion of their salaries in this Fund, and their employers put in a matching amount?

The Employees’ Provident Fund is a retirement benefit scheme that was structured to provide financial security to employees of factories and other establishments post-retirement. It is administered by the Employees’ Provident Fund Organisation (EPFO) whose highest body is the Central Board of Trustees, with representation from the government, employers and employees.

While 12% of the basic salary and dearness allowance has to be contributed by all employees earning up to Rs 15,000 per month (not mandatory for others), the employer component (12%) has to be contributed mandatorily in case of all employees. The employer’s component is split into EPF (3.67%) and the Employees’ Pension Scheme (8.33%).

Watch | PF Tax: Making Sense Of Govt’s Clarification

The return on EPF is decided by the government every year. For 2015-16, the government has announced a small increase to 8.8% from 8.75% for 2014-15.

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EPF has so far been EEE, or Exempt-Exempt-Exempt. What does this mean?

EEE means that the investment in the EPF is tax-free at all the three stages of investing, interest accumulation, and withdrawal. The EEE status is also available to Public Provident Fund, equity linked savings schemes and life insurance policies.

How has this year’s Budget changed this situation? What has the Finance Minister now proposed?

As part of its Budget 2016-17 announcements, the government has proposed to impose a tax on 60% of the corpus at the time of withdrawal. While concerns and apprehensions have been raised from various quarters including employees’ representatives on the Central Board of Trustees, the government, in its clarification issued on Tuesday, said that “The Government has announced that Forty Percent (40%) of the total corpus withdrawn at the time of retirement will be tax exempt both under recognised Provident Fund and NPS… It is expected that the employees of private companies will place the remaining 60 per cent of the Corpus in Annuity, out of which they can get regular pension. When this 60 per cent of the remaining Corpus is invested in Annuity, no tax is chargeable. So what it means is that the entire corpus will be tax free, if invested in annuity.”

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What is the government’s rationale for doing this?

Announcing the imposition of tax on 60% of the withdrawal amount from EPF, the government in its Budget document argued that it was being done to bring greater parity in the tax treatment of different types of pension plans. However, in its clarification issued on Tuesday, the government said, “The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account.”

How does the Budget announcement change the financial planning outlook of investors the bulk of whose savings are in EPF?

The government has specifically said that the contributions made until March 31, 2016 will attract no tax at the time of withdrawal. It will be only applicable on contributions made on or after April 1, 2016. Since 60% of the future contributions and interest earnings on them will be taxed at the time of withdrawal, it will impact investors who plan to pull the entire corpus at the time of retirement. However, it will not impact those who plan to buy an annuity product out of the 60 per cent of the corpus (from an insurance company), for getting regular pension after retirement.

Arguments in Favour of the Tax

The government says it will bring parity among provident fund, pension funds and the National Pension System (NPS). Experts say that this will allow investors to choose a product based on the returns they generate and the risk exposure they carry, and not on the basis of the tax benefit they offer.

Watch | The Big Picture Of Arun Jaitley’s Budget 2016

Some experts say that the government’s move will make the NPS more popular among investors, as it allows investments to be routed to equity markets that have the potential to generate higher returns. Since the money can be routed to equity markets, it will free up the capital, and can be used in the growth of the economy.

Another argument put forward by the government is that the move will force employees to place the 60 per cent of the corpus in annuity for getting a regular pension. In case the employee puts 60 per cent of the corpus in annuity, the entire corpus becomes tax free.

Arguments against the tax

The first argument is that while the government is continuing with the EEE tax benefit for equity linked savings schemes by mutual funds and unit linked insurance plans where middle and large income investors invest, it is proposing to remove EEE benefit from EPF, where the majority of contributors are assumed to be in the low income bracket.

EPFO is the only retirement saving for workers in the low income group, and an imposition of tax at the time of withdrawal will rob them of a sizeable portion of their long-term savings.

Some argue that since the contribution to EPF goes from tax-paid income, if the government imposes tax at the time of withdrawal, it will be like taxing them twice on the same income.

A majority of low income workers withdraw their EPF money in full at the time of retirement to buy a house or for other important purposes — and restricting them by imposing tax on 60 per cent of the corpus will erect hurdles in their achieving their goal.

Keystrokes: EPF Tax

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First Published on: March 2, 2016 12:38 am
  1. A
    Mar 2, 2016 at 2:32 am
    Yes. Rob common people and make them slaves so that they always remain under your command and mercy. This is Anti national budget.
    1. A
      Mar 2, 2016 at 4:32 am
      Modi ji Voter show you Acha din on 2019...
      1. A
        Mar 2, 2016 at 1:22 am
        The very idea is foolish this shows that lawyers cannot be finance minister Mr jaitely please quit other wise it would bring the down fall of Mr Modi
        1. C
          Col S
          Mar 2, 2016 at 2:17 am
          BJP/ MODI have lost TRUST of PUBLIC berng JUMLA KING. This is the another nail in therir DESIGNS for future.COWARDS__ unable to RECOVER monery from FRAUDSTERS and WRITE off Rs 4 lakh crores NPA.but MAD Enough to TAX SMLL SAVERS who are the BACKBONE of the country. ADVISORS will SINK the PARTY . They KNOW neither the pulse nor the GOVERNANCE. Our MISFORTUNE..
          1. D
            Deeply Concerned
            Mar 2, 2016 at 4:18 pm
            Now the w country wil know how this fake lawyer almost ruined DDCA and now with his backdoor entry into ministry after loosing elections, has disturbed the sleep of the working middle cl. Rajya Sabha must force a law to keep unelected people from gaining back door entry, with this India will be saved from two or three of the most serious trouble makers in Indian history - one from Education Ministry and the other Finance. By giving these two ministerial post, Modi has shown disrespect to the Indian voters.
            1. D
              Mar 2, 2016 at 5:00 am
              This is a government without ideas --not that the previous one had any. They have woken up to the fact that the "rich" need no subsidies. Fine up to that point. But they also need to protect the super rich. So they go for the sitting duck --the ried cl. Anybody above the so-called poverty line is henceforth "rich". So a struggling clerk in a MSME private company is equal to Mukesh Ambani when it comes to taxation.
              1. G
                Girish Ramaiah
                Mar 2, 2016 at 3:36 am
                Budget 2016 has initiated the downfall of BJP. Middle cl is very disappointed. MPs and LAS are unilaterally increasing their ry and perks and avoiding paying income tax. Taxing EPF is the worst decision taken by any FM since independence.
                1. G
                  Girish Ramaiah
                  Mar 2, 2016 at 3:30 am
                  Let FM explain how is Government planning to recover huge NPA from wilful defaulters like Mallaya. Why Banks are not sending Gonads to their residence to recover loan? Their is a nexus between politicians from all parties and willful defaulters. Taxing EPF is the worst decision taken by any Government so far. BJP has to pay a heavy price for this decision.
                  1. I
                    Mar 2, 2016 at 5:41 am
                    The Government is trying to fool people in order to please private Insurance Companies and Mutual Fund Houses. In the year September 2014, The government brought notification to deny Pension fund membership under the Employees Pension Scheme 1995 ( EPF) to those employees which initial pay of more than Rs 15000. Therefore the argument of the Government that thy want to encourage pension society is hollow. Also: Government and Economists wants EPFO to invest in equities saying it will give more return on investment. EPFO now says, it can give 9% interest and still have surplus in the corpus. Government says “NO”. Reason – Government wants to reduce interest rates on small savings.
                    1. S
                      Mar 2, 2016 at 6:32 pm
                      Modi is showing their failure in reducing corruption and stop black money. The only way to increase the income is by taxing ried cl. Then more money will flow for infrastructure development and 70% of the money will be looted by politicians and contractors
                      1. K
                        Mar 3, 2016 at 12:47 pm
                        This government takes all the money saved due to fall in the fuel prices in the international market, without ping the savings to the people. May be that is not sufficient for them? Now they focussed on how to rob the hard earned money from people. This government is totally anti-ried people.
                        1. M
                          Mar 2, 2016 at 9:10 am
                          If the entire 60% corpus is taxed at a top slab rate of 30.9%, the average tax on the entire corpus comes to 18.54%. If just the interest on 60% of the contribution gets taxed, then the tax will be small. Mint got a confirmation () from the revenue secretary that it will be just the interest that will be taxed and not the full 60% corpus. We ran some numbers to see what the tax looks like (). Suppose a person joins in the next fiscal and sees a ry growth of 10% a year for the next 40 years. ume that EPF interest remains a steady 8% over this 40-year period. Unrealistic, I know, but we need to ume something for a back-of-the-envelope calculation. A tax on the interest corpus at 30.9% works out to an average tax rate of 1.4% on the entire corpus. Not bad at all.
                          1. A
                            Mar 2, 2016 at 4:53 am
                            It's like comparing apples and oranges. EPF and NPS are different concepts - provident and pension. EPF is guaranteed returns; NPS is market-linked. Govt is giving a specious argument in aligning the two products. The divide is also between private and Govt sector employees. Who's money is it anyway? Say in the case of dual-income families, the husband and wife can jointly decide how to allocate funds for family expenses - could be higher education, or purchase of property. Why should Govt dictate how my hard-earned funds should be allocated? Annuity plans are dud investments - returns are low, and entire pension amount is included in gross income. Looks like proposed tax is meant to fund pay to Govt employees and offset 7th Pay Commission, and Eight and Ninth...
                            1. A
                              Mar 5, 2016 at 11:34 am
                              BJP is cheating people. Just do not vote for these guys, They want to take our savings to feed likes of Ambanis and Mallayas
                              1. R
                                Rajiv Rockx
                                Mar 2, 2016 at 6:12 am
                                this is a pure partyline budget nothing else
                                1. R
                                  Mar 2, 2016 at 10:21 am
                                  It seems you and FM are doing us a great favour by forcing us to invest in pension funds or taxing our life time savings. Great !! The ry cl will return this favour with interest in 2019 GE.
                                  1. R
                                    Mar 2, 2016 at 10:23 am
                                    You are right sir. This Govt has betra our trust in 2 years....
                                    1. E
                                      Eve Fernandez
                                      Mar 2, 2016 at 5:18 am
                                      This is just the begining of GOVT laying their hands on the PF amount. In years to come the taxation on this will go on increasing(60 percent will become 100 percent) and finally the full contribution will be taxed. Remember service tax? The ries cl has to unite and fight and brook and no attempt by Govt to lay their hands on this amount. The proposal should be fully withdrawn. No partial roll back. It is also to be remembered that any amount we get today as PF settlement will be eroded due to inflation in just 5 years. The big amount to day will have lost its value in 5 years.
                                      1. R
                                        Mar 2, 2016 at 3:58 am
                                        BJP government is a modern day Robin Hood which steels from the poor and middle cl employees EPF and gives the booty to the benefit of crony capitalists and big ticket bank loan defaulters. This is called the “Banya Jan Party’s” MODIfied ache din. ANYBODY REMEMBERS, THE COMPULSIVE LIARS NARAGENDRA MODI AND SUBRAMANIAM SCAMY SHOUTED FROM THE ROOF TOP DURING THE LAST ELECTION THAT THEY WILL TOTALLY ABOLISH THE INCOME TAX AND DEPOSIT 15 LAKH IN EVERYBODY’S SB ACCOUNT, IF BJP COMES TO POWER !. ***
                                        1. R
                                          Mar 2, 2016 at 11:46 am
                                          If Govt has courage bring back the BLACK MONEY from SWISS BANK
                                          1. R
                                            Mar 2, 2016 at 11:41 am
                                            This act of Govt is worse than terrorist attack.Attacking ried people an encouraging non-performing NPS funds
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