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March 24, 2021

Provident Fund Investment up to Rs 5 Lakh will be Tax free

by CA Jessica Nagaonkar in Compliance Law

Provident Fund Investment up to Rs 5 Lakh will be Tax free

In today’s market there are many investment options available depending upon individual preferences. Some of the most sought out investment options are ULIP’s and investment in PF. A provident fund is a retirement fund run by the government. They are generally compulsory, often through taxes, and are funded by both employer and employee contributions. Governments set the rules regarding withdrawals, including minimum age and withdrawal amount. If a participant dies, his or her surviving spouse and dependents may be able to continue drawing payments.

Statutory Provident Fund (SPF) or General Provident Fund (GPF) is maintained by Government and Semi-Government organizations. The Government employee contributes a certain amount of salary to this fund. The accumulations in this fund are paid to the Government employee at the time of retirement or superannuation.

Every Government employee can have this account but the GPF is not available to the private sector employees. This fund can be used to draw advances known as GPF advances which are interest-free and are to be repaid in monthly instalments. There is no bar on the number of GPF advances. This fund matures at retirement or superannuation.

Tax Treatment of PF

Contribution is made in the Provident Fund for the employee’s welfare by the employee and the employer. The deduction is available under section 80C. Provident fund is a kind of security fund in which the employees contribute a part of their salary and the employer also contributes on behalf of their employees. Section 10(11) and 10(12) of the Income Tax Act defines the exemption on the amount added to the provident fund. Additionally, the amount allowed as a deduction on contributing to the provident fund is dealt in section 80C of the Income Tax Act.

ParticularsRecognised PFUnrecognised PFStatutory PFPublic PF
Employer’s ContributionContribution to 12% of salary is exempt, above that is added to salary income of the employee.Not taxableNot taxableNot taxable
Employee’s ContributionSection 80C DeductionNo Section 80C deductionNo Section 80C deductionNo Section 80C deduction
Interest on PFAny interest over and above 9.5% is added to Income from Salaries. Until 9.5% interest is exempt.Not taxableExemptExempt

Increase in deposit limit of PF

  • The Government has now raised the deposit threshold limit to Rs 5 lakh per annum in provident fund for which interest would continue to be tax exempt.
  • This would be applicable to those cases where no contribution is made by employers to the retirement fund.
  • Tax on interest on provident fund contribution affects only 1% of the contributors, and the remaining are not impacted as their contribution is less than Rs 2.5 lakh per annum.
  • However, this increase in limit will provide a major relief to large number of middle- to high-income earners

Let us understand the same with the help of an example

  • What this means that if an individual’s own contribution to the employees’ provident fund in a month is up to Rs 41,666 (Rs 5 lakh in a year), there will be no tax on the interest income.
  • However, if the contribution exceeds that, then interest income on additional contribution will be taxed.
  • This means that individuals having monthly basic salary of over Rs 3,47,216 will now get impacted by the move as their annual EPF contributions (at the rate of 12% of basic salary) would exceed Rs 5 lakh.
  • So, if an individual contributes Rs 12 lakh in a year, the tax will be applicable on interest income on Rs 7 lakh (Rs 12 lakh -Rs 5 lakh).
  • While the interest income on Rs 7 lakh would amount to Rs 59,500 (at EPF interest rate of 8.5%), the tax payable on the same would be Rs 18,450 (at marginal tax rate of 30 %).

Amendment Passed in the Finance Bill 2021

  • Finance Minister Nirmala Sitharaman had in the Budget presented to Parliament on 1st February provided that interest on employee contributions to provident fund over Rs 2.5 lakh per annum would be taxed from April 1, 2021.
  • Replying to the debate on the Finance Bill 2021 in the Lok Sabha, Sitharaman made the announcement regarding raising the limit to Rs 5 lakh in cases where employers do not make contributions to the provident fund.
  • The Finance Bill, which gives effect to tax proposals for 2021-22, was approved by voice vote.
  • The bill was passed after acceptance of 127 amendments to the proposed legislation.

Some other tax proposals to be undertaken

Referring to the issues raised by various members on higher taxes on motor fuel, Sitharaman said she would love to discuss the issue of bringing petrol and diesel under GST in the next GST Council meeting. She also sought to remind members that it was not just the Centre which taxes motor fuel and states also imposed levies.

The finance minister also said rationalisation of customs duty structure will be undertaken to help domestic businesses, especially the MSME segment. On taxes, she emphasised on the need for widening the tax base. With regards to the equalisation levy, she said this is meant to provide a level playing field to domestic businesses which pay taxes in India.

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