How provident is this fund?

The difficulties faced by the EPFO are well known. In recent years the top management of the EPFO has been trying to address some of its problems. The problems with the 2500-odd exempt funds which are known to default on contributions and have difficulties in paying the high interest rates that match the EPF rate are also known. But almost nothing is known about the “excluded funds”. How many companies are running their own provident fund schemes? What schemes are they offering? Do they have the ability to meet their obligations? Is the money actually invested by the company in conformity to its claims? What happens if the company goes bankrupt? What if the money is stolen?

Today the government knows nothing about number of such funds, the size of their assets or the number of employees under these schemes. Informed guesswork suggests that assets in this sector could be in the region of Rs 1,00,000 crore, or roughly half the size of the Indian mutual fund industry. Every year companies get income tax exemptions if they say that the PF investments they are making follow the investment guidelines laid down by CBDT. But since this is done at the level of regional income tax offices, there is no central database that keeps this information in one place.

Worse, these PF schemes are completely unregulated. What sort of benefits are they offering? Are the interests of the subscribers being looked after? There is no way to check that there is no fraud or malpractice in the running of the schemes. What if there is a default? In the absence of a database and a regulator, there is no option for a subscriber but to go to court in case he is cheated. Thereafter, it may be decades before he gets justice.

There is clearly good reason to remedy this situation. However, what the Finance Bill 2006 has proposed is a giant step in the wrong direction. It has proposed that unless an excluded fund is recognised by the EPFO, it will not be recognised by the income tax department. This means either some companies will not take tax breaks, which is unlikely, or they will rush to get recognition by the EPFO. It is difficult to believe that the finance minister is serious about this proposal. The EPFO is not a regulator: it simply lacks the capacity to perform regulatory functions for excluded funds. After the public differences between the high interest rates on EPF demanded by trade unions and the finance minister who has, correctly, been unwilling to give a subsidy to the EPFO, it is odd to see this leap of faith in the EPFO.

While it is not entirely clear from the wording of the Finance Bill that it seeks to equate the status of the excluded PFs which will be “recognised” by the EPFO to that of the present “exempt” funds, if it does, then it implies three things. First, the EPFO will have to regulate all these funds which it does not have the capacity to do, and we even don’t know how many funds there are. Second, these funds will have to pay interest rates that match the politically decided EPF interest rate which could well push them into bankruptcy. And third, that if a company defaults, the PF payment will be a headache of the EPFO. Since no one knows how large is the size of the problem, this could open up a can of worms bigger than the EPFO can handle.

With a deficit of Rs 22,000 crore in its pension scheme (EPS) and with barely 25 per cent of its accounts in proper shape, the finance minister ought to have serious doubts about the EPFO’s capacity to handle the implications of the proposal in the Finance Bill. On the other hand, this could be an omission in the Finance Bill and may be corrected before the bill is passed.

The best way ahead might be first merely to ask the companies running exempt funds to register with the ministry of finance. They should be asked to provide basic information about the number of employees covered, size of assets and the nature of scheme before being eligible for income tax deductions. This will give the government a sense of the scale of the problem. Next comes the question of how to regulate these schemes. This question can be tackled by PFRDA. However, at this stage even a registration will be a big step ahead and provide valuable information before a policy decision is made. If the FM does not correct this omission it may prove to be a very costly one for the EPFO.