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 1^st 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.

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Know all 80C deduction you can invest or avail for FY 2020-21 before 31^st March 2021

Taxpayers can seek Deduction under Chapter VI A, which would help them reduce them taxable income. There are a lot of deductions available under various sections to help taxpayers bring down their taxable income. Each of these sections caters to a specific type of investments or expenses

Section 80C is the most important way of saving taxes. It allows taxpayers to reduce their taxable income by making investments and some expenses and thus save on taxes they pay. Currently, section 80C allows deduction from gross total income (before arriving at taxable income) of up to Rs 1.5 lakh per annum on eligible investments and specified expenses.

Eligible investments include life insurance, equity-linked savings schemes, Public Provident Fund, National Savings Certificate, five-year notified tax-saving bank deposits, five-year post office time deposits, Senior Citizens’ Savings Scheme, Sukanya Samriddhi Account and Employees’ Provident Fund. Expenses and outflows are tuition fees, principal repayment of home loan, etc. One can invest the entire amount of Rs 1.5 lakh in one investment or diversify across more than one. Let us learn more about deductions under Section 80C in this article.

Home Loan Principal Repayment

The Indian government has always shown a great inclination to encourage citizens to invest in a house. This is why a home loan is eligible for tax deduction under section 80C.
When assessee’s buy a house on a home loan, it comes with multiple tax benefits too that significantly reduce your tax outgo.
The Principal portion of the EMI paid for the year on home loan is allowed as deduction under Section 80C.
But to claim this deduction, the house property should not be sold within 5 years of possession.
Otherwise, the deduction claimed earlier will be added back to your income in the year of sale.
Further, any payment made to development authorities like Delhi Development Authority (DDA) in order to purchase a house (which has been allotted to you in a scheme made in this regard) also qualifies as deduction under section 80C.

Life Insurance Premium

Payment of premium on life insurance policy not only gives insurance cover to a taxpayer but also offers certain tax benefits. The investment in life insurance can be deducted up to Rs 1,50,000.

In case of an individual, deduction is available in respect of policy taken in the name of taxpayer or his/her spouse or his/her children. In case of a HUF, deduction is available in respect of policy taken in the name of any of the members of the HUF.

Section 80C of the Income Tax Act provides deduction up to Rs 1,50,000 provided taxpayers invest according to condition given below:

Policy Issued from 01.04.2012 – premium paid not in excess of 10% of Capital Sum Assured (as amended by Finance Act 2012).
Policy Issued from 01.04.2003 and on or before 31.03.2012 – premium paid not in excess of 20% of Capital Sum Assured
Policy Issued from 01.04.2013 – premium paid not in excess of 15% of Capital Sum Assured (Inserted by the Finance Act, 2013, w.e.f. 1-4-2014).

Provident Fund Investment

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 or General Provident Fund 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.

As per Section 6 of the Provident Fund Act, if an employee so desires, he/she can make provident fund contribution in excess of the statutory rate subject to the condition that the employer shall not be under an obligation to pay any contribution over and above its contribution payable under the law. Thus, an employee can make Voluntary Provident Find (VPF) contributions at any time while he/she is a contributory member of Employees Provident Fund (EPF).

PPF is a scheme provided by the government. One can invest as low as Rs 500 and as high as Rs 150000 in a financial year. The normal maturity period is 15 years. The interest rate is assured but not fixed.

Employee’s contribution to any provident fund (apart from unrecognised provident fund) is eligible for deduction under Section 80C up to Rs 1,50,000.

Investment in Equity Linked Savings Scheme (ELSS)

ELSS funds are equity funds that invest a major portion of their corpus into equity or equity-related instruments.
ELSS funds are also called tax saving schemes since they offer tax exemption of up to Rs. 150,000 from your annual taxable income under Section 80C of the Income Tax Act.
Further, these schemes have a mandatory lock-in period of 3 years.
Therefore, on redeeming the units, investors receive long-term capital gains or LTCG. These gains are not taxable up to Rs. 1 lakh in one financial year. Any LTCG above this limit is taxed at 10% of the gains exceeding Rs. 1 lakh without indexation.

Investment in Sukanya Samriddhi Account

Sukanya Samriddhi Yojana is one of government-backed small savings schemes under the Beti Bachao, Beti Padhao campaign, that can help parents secure the future of their girl child.
One of the reasons why this scheme has become popular is due to its tax benefit.
It comes with a maximum tax benefit of Rs 1.5 lakh under section 80C of the Income-tax Act.
Further, the interest accrued and maturity amount are exempt from tax.
Only parents or legal guardians of the girl child can open a Sukanya Samriddhi account in the name of the girl.
The girl child should be less than 10 years at the time of account opening. The account can be operational till the girl reaches the age of 21 years.
A single girl child cannot have multiple Sukanya Samridhhi accounts.
Only two Sukanya Samriddhi Yojana accounts are allowed per family i.e., one for each girl child.
The account will have to be closed if the girl child becomes an NRI or loses her Indian citizenship.

Investment in National Savings Certificate (NSC)

The National Savings Certificate is a fixed income investment scheme that investors can open with any post office.
A Government of India initiative, it is a savings bond that encourages subscribers, mostly small to mid-income investors to invest while saving on income tax.
A fixed-income instrument like Public Provident Fund and Post Office FDs, this scheme too is a secure and low-risk product.
One can buy it from the nearest post office in their name, for a minor or with another adult as a joint account.
The certificates earn a fixed interest and come with a fixed maturity period of five years. There is no maximum limit on the purchase of NSCs, but only investments of up to Rs.1.5 lakh can earn a tax break under Section 80C of the Income Tax Act.

Investment in Infrastructure bonds

Popularly called Infra Bonds, these are issued by infrastructure companies, not the government. The amount invested in these bonds can also be included in Section 80C deduction.
Infrastructure bonds are good for people who need a fixed income.
They offer a decent rate of interest and tax benefits.
The maturity of these bonds is often between 10 to 15 years with an option to buy-back after a lock-in of 5 years.
These bonds are listed either on or both National Stock Exchange or Bombay Stock Exchange that provides you with an option to exit after the lock-in period.

Investment in Fixed Deposits

Any term deposit with a tenure of at least five years with a scheduled bank also qualifies for deduction under section 80C and the interest earned on it is taxable.

Investment in Senior Citizen Savings Scheme (SCSS)

This scheme, as the name suggests, is meant only for senior citizens.
Any individual in the 60 or above age group can open an account under this scheme.
An individual above 55 but less than 60, and having retired under a Voluntary Retirement Scheme or a Special Voluntary Retirement Scheme, can also open an account under this scheme, but such an account must be opened within three months of the retirement date.
If you are retired defence personnel, then you can open this account without any age limit, provided you fulfil other specified conditions.
Any investment in this account would be eligible as deduction under Section 80C.
The interest is payable quarterly instead of compounded quarterly. Thus, unclaimed interest on these deposits won’t earn any further interest and also the interest earned is chargeable to tax. Interest on this scheme is also reset every quarter by the government for new accounts opened under the scheme.

Investment in Five-year Post Office Time Deposit (POTD) Scheme

POTDs are similar to bank fixed deposits.
They are available for different time durations like one, two, three and five years but only five-year POT qualifies for tax-saving under section 80C.
The interest rates offered by them is compounded quarterly, but paid annually.
The interest earned is entirely taxable.

Investment in NABARD Rural Bonds

The NABARD Rural Bonds issued by NABARD (National Bank for Agriculture and Rural Development) also qualify for deduction under section 80C. These bonds are tax-free and also offer decent interest rates.

Investment Unit linked Insurance Plan (ULIP)

Unit Linked Insurance Plan (ULIP) is a mix of insurance along with investment.
From a ULIP, the goal is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with the investor’s long-term goals.
Premium paid on ULIPs is eligible for a deduction under Section 80C up to a maximum of Rs 1.5 lakhs during a year.

Payment of Tuition Fees

A parent can claim a deduction on the amount paid as tuition fees to a university, college, school or any other educational institution. Other components of fees like development fees and transport fees are not eligible for deduction under Section 80C.

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