Tax Free Provident Fund Investment up to Rs 5 Lakh, what does this mean for you?
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.
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. This will be applicable for all contributions beginning April 1, 2021.
What does this amendment entail?
This amendment 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.
Does this amendment affect private sector employees?
- The amendment 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, as both employers and employees contribute at least 12% each of basic wages to the Fund.
- 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.
- 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%)
- In case of EPF, the interest income shall be taxable under the head ‘Income from other sources’.
- Such income should be taxable as a residuary income as it is not accruing from a source emanating from an employer and employee relationship.
- The interest income will become part of the total taxable income of the taxpayer.
- There is no special rate for the taxability of this interest. Hence, such income shall be taxed at the prevailing income tax rates.
Who will benefit from the amendment?
The amendment 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% of CTC) are covered under it.
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%).
What should taxpayers do to avail the benefit of the amendment?
- 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 could 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% for gains above Rs 1 lakh, the long-term tax on debt funds is 20% with indexation benefit.
- 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.
On the move, the finance minister Nirmala Sitharaman had said that, this fund is actually for the benefit of the workers, and workers were not going to be affected by it. It was only for big ticket money which came into it because it had tax benefits and also (is) assured about 8% 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% return, we thought this is probably not comparable with an employee with about Rs 2 lakh.