The Union Budget 2021-22 has made a proposal to tax the interest income on Provident Fund (PF) contributions by employees that exceed Rs. 2.5 lakh annually. The Finance Ministry has voiced its concern about investments as large as Rs. 1 crore being funneled into the PF each month and questioned the fairness of these investors receiving both tax concessions and assured returns.
About the Employees’ Provident Fund (EPF) Scheme
The Employees’ Provident Fund (EPF) Scheme, which falls under the management of the Employees’ Provident Fund Organisation (EPFO), is a government initiative that oversees provident fund and pension accounts for workers in India’s organised sector. The EPF is open to both public and private sector employees. Moreover, any organisation employing at least 20 individuals must mandatorily extend EPF benefits to its staff.
How Does the Employee Provident Fund Work?
Both the employer and employee contribute 12% of the employee’s monthly salary (comprising basic wages plus dearness allowance) to the EPF scheme. From the employer’s share of 12%, 8.33% is redirected towards the Employees Pension Scheme (EPS). The EPF scheme is mandatory for employees earning a monthly basic wage of Rs. 15,000 or more. EPFO declares the EPF interest rate annually, which is exempt from taxes under Section 80C of the Income Tax Act.
The Proposed Tax on Income
The proposal stipulates that if the total annual contribution to EPF (inclusive of the gratuity and voluntary contributions) exceeds Rs 2.5 lakh, then the interest income will be taxed at the marginal tax rate applicable to the individual. Only the contribution linked to the employee’s component will be subjected to taxation; the employer’s contribution will not be included in the calculation. The interest income on the additional contribution of a year will be taxed every year, but the proposal is unlikely to impact average EPF contributors.
Reasons for Taxing Interest Income on PF Contributions
The government’s primary motive for tax implementation is to prevent the misuse of the scheme. Instances have been found where employees contribute large sums to these funds, thereby enjoying tax exemption at several stages – during contribution, interest accumulation, and withdrawal. This loophole enables high net worth individuals (HNIs) to deposit colossal amounts in EPF, earning them both assured interest and tax-free income. Earlier, the annual contribution limit by employers into employee welfare schemes such as EPF was capped at Rs. 7.5 lakh. However, both government and private employees can still make voluntary contributions over and above statutory deductions.
Assuring Equity among PF Contributors
The tax announcement also aims to promote fairness among PF contributors. Of the estimated 4.5 crore EPF accounts, only about 0.27% members had an average corpus of Rs. 5.92 crore, and they were earning over Rs. 50 lakh per year as tax-free guaranteed interest. The new tax proposal is aimed at curbing this misuse of a welfare scheme intended primarily to support the savings efforts and provide social security to the lower and middle-income groups of employees.
