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Monday, June 27, 2022

Explained: What increase in taxable Provident Fund limit means for you

While in the Budget 2021-22, the finance minister had proposed to tax interest income on own contribution of employees exceeding Rs 2.5 lakh a year, the government in its amendments to the Finance Bill 2021, proposed to raise the limit to Rs 5 lakh.

By: ENS Economic Bureau , Edited by Explained Desk | New Delhi |
Updated: March 30, 2021 8:35:01 am
EPF, EPF contributions, EPF tax, Tax on EPF contributions, Indian ExpressThe government proposal states tax will be on the interest income on the contribution exceeding Rs 5 lakh in the previous year. (File Photo)

In a move that will allow government officials to park double of what is available to private sector employees for earning tax-exempt income on provident fund contribution, the government, Wednesday, introduced an amendment to the Finance Bill, 2021. In its amendment, the government proposed to double the cap on contribution from Rs 2.5 lakh to Rs 5 lakh for tax exempt interest income, if the contribution is made to a fund where there is no contribution by the employer.

In the budget 2021-22, the finance minister had proposed to tax interest income on own contribution of employees exceeding Rs 2.5 lakh in a year. However, with this amendment, the limit for government employees now stands revised at Rs 5 lakh. This will be applicable for all contributions beginning April 1, 2021.

What is the amendment?

In the budget proposal last month the government had proposed, “to restrict tax exemption for the interest income earned on the employees’ contribution to various provident fund to the annual contribution of Rs 2.5 lakh.”

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Wednesday, the government brought in an amendment that doubles the limit of contribution from Rs 2.5 lakh to Rs 5 lakh for tax-exempt interest income, for government employees.

The Amendment to the Finance Bill, 2021 read, “Provided further that if the contribution by such person is in a fund in which there is no contribution by the employer of such person, the provisions of the first proviso shall have the effect as if for the words “two lakh and fifty thousand rupees”, the words “five lakh rupees”had been substituted.”

What does it mean?

This means that additional contribution of Rs 2.5 lakh can be made to a fund where the employer makes no contribution. So, the fund that qualifies for it is General Provident Fund that is available only to government employees.

While it does not change anything for the private sector employees’ from what was proposed in the Budget, the government employees will now be able to contribute up to Rs 5 lakh and earn tax-free interest on that amount.

For private sector employees though, if they contribute any amount beyond Rs 2.5 lakh as their own contribution, tax will be applicable on the interest income of the additional contribution.


Who benefits?

The decision to increase the cap on EPF contributions that will have tax-exempt interest income, from 2.5 lakh to 5 lakh per annum, will ensure that individuals earning annual basic salary of up to Rs 41.66 lakh or total salary of around Rs 83 lakh (if basic is 50 per cent of CTC) are covered under it.

So, if a private sector individual contributes Rs 12 lakh in a year, the tax will be applicable on interest income on Rs 9.5 lakh (Rs 12 lakh -Rs 2.5 lakh). While the interest income on Rs 9.5 lakh would amount to Rs 80,750 (at EPF interest rate of 8.5%), the tax payable on the same would be Rs 25,000 (at marginal tax rate of 30%).

What should you do?

Since the increase in investment limit does not benefit private sector employees, high salaried employees’, whose annual PF contribution is over Rs 2.5 lakh need to reconsider their options. Investors who are not comfortable with debt or equity mutual funds and are willing to pay tax at marginal tax rate on the interest income (on additional contribution) could still go for contribution in provident funds. However, those who are comfortable investing in mutual funds can got for AAA rated debt schemes or diversified large cap funds for more tax efficient long term gains. While long term capital gains tax (after 12-months) for equity schemes stands at 10 per cent for gains above Rs 1 lakh, the long term tax on debt funds is 20 per cent with indexation benefit.

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So for tax efficiency purposes and better returns, it is advisable to stop the voluntary contribution to PF if it exceeds Rs 2.5 lakh in a year, as the interest income will get taxed at marginal tax rate.

Why did the government propose to tax interest income on EPF?

Justifying its move in February, the government stated that it had found instances where some employees were contributing huge amounts to these funds and getting the benefit of tax benefit. With an aim to exclude HNIs from the benefit of high tax-free interest income on their large contributions, the government proposed to impose a threshold limit of contribution at Rs 2.5 lakh for tax exemption.

On the move, the finance minister Nirmala Sitharaman, last month, said “This fund is actually for the benefit of the workers, and workers are not going to be affected by it…it is only for big ticket money which comes into it because it has tax benefits and also (is) assured about 8 per cent return. You find huge amounts, some to the extent of Rs 1 crore also being put into this each month. For somebody who puts Rs 1 crore into this fund each month, what should be his salary. So, for him to give both tax concessions and also an assured 8 per cent return, we thought this is probably not comparable with an employee with about Rs 2 lakh.”

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