The Finance Ministry recently brought to light the rules about taxing interest income on contributions made to the Employees’ Provident Fund (EPF). The EPF is a prime scheme under the Employees’ Provident Funds and Miscellaneous Act, 1952, that introduces provident funds for employees of factories and other establishments. As per the existing law, every employee whose monthly salary is Rs.15,000 or less becomes an obligatory member of the EPF. This article explores the new taxation rules and their nuances.
Historical Context
In February 2021, the annual Budget proposed that tax exemption shall no longer be available on interest incomes from Provident Fund (PF) contributions exceeding Rs 2.5 lakh per year. Fast forward to March 2021, the government presented an amendment to the Finance Bill, 2021. It suggested doubling the tax-exempt interest income cap to Rs 5 lakh given that the contribution was made to a fund where there’s no contribution by the employer. This move provided respite for contributions made to the General Provident Fund, a provision exclusive to government employees and not requiring any contribution by the employer.
New Rules Overview
According to the recent notification by the Finance Ministry, interest income on contributions to EPF surpassing Rs. 2.5 lakh for private sector employees and Rs.5 lakh for government employees is liable to tax. These rules will be enforced starting this Fiscal Year (FY) 2021-22, in which the government will tax interests on contributions exceeding these limits.
Separate accounts must be maintained within the provident fund account for 2021-22 and following years for taxable and non-taxable contributions by an individual. The Central Board of Direct Taxes (CBDT) has added Rule 9D to the Income-Tax Rules, 1962. The rule states that income through ‘non-exempt’ interest accrued during the prior year (above Rs 2.5 lakh for private and Rs 5 lakh for government employees) will be calculated as the interest accrued during the previous year in the taxable contribution account.
Tax Perpetuity
As per the new rules, the interest income on additional contributions (over Rs. 2.5 lakh for private sector employees and Rs. 5 lakh for government employees) for a year will attract tax every subsequent year. This means, if a person’s annual contribution to PF in FY 2021-22 is Rs 10 lakh, the interest income on Rs 7.5 lakh will invite tax not just for FY 2021-22 but also for all ensuing years.
Why the Change?
The Budget proposal pointed out that the government had found instances of employees contributing massively to these funds and reaping the benefits of tax exemption at all stages – during contribution, interest accumulation, and withdrawal. To prevent High Net-Worth individuals from unwarranted benefits of substantial tax-free interest income on their large contributions, the government has set a threshold limit for tax exemption.
