Finance Minister Nirmala Sitharaman has recently announced that contributions exceeding Rs. 2.5 lakh in the Employee’s Provident Fund (EPF) will be taxed in the manner interest accrued on fixed deposits are taxed. The announcement made in the Union Budget event has notified that this recent amendment will be in function from the next financial year.
The Central Government’s move may impact employees with high income and people who make considerable contributions to the PF accounts. However, the government has denied such claims stating that it will only affect less than 1% of the account holders and put forth that this change has been introduced to keep a check on wealthy people storing money in EPF accounts to earn tax-free interests. Read on to know how the government plans to tax contributions above Rs. 2.5 lakhs in PF accounts.
Employees Provident Fund is an instrument initiated by the government to help the employees park money for their retirement. This is the only fund-saving scheme where one enjoys tax exemption at the time of depositing, on accumulation, and at the time of withdrawal. However, with the recent amendment, i.e., clause 5 of the money bill 2021, the interest on contributions exceeding Rs. 2.5 lakh will be taxable from the 1st of April, 2021.
Existing Provisions Concerning Taxation on EPF Contributions
Let us understand the existing provisions w.r.t EPF contributions to better comprehend the new modifications.
- As per Section 10(11) and 10(12) of the Income Tax laws, the employees are provided with an exemption in statutory PF and recognized PF, respectively.
- The interest that is credited to the PF accounts of the employee is completely free from taxation.
- As the money deposited in EPF fall under the EEE (Exempt-Exempt-Exempt) mechanism, the employee did not have to bear any tax during investing, earning, and withdrawing.
Proposed Modifications to be Incorporated by the Government
As per the new rules given in the Financial Bill 2021, the interest accrued in the employee’s PF account over Rs. 2.5 lakh will become taxable at a standard rate. However, note that this will only apply to the employee’s contribution and not the employer’s. Go through the points mentioned below to know the features of the proposed amendment.
- The recent proposition on the taxation on EPF contributions will only be applicable for the investments made on or after the 1st of April, 2021.
- The entire chunk of the employee’s investment, employer’s investment, the interest accrued on the employer’s contribution, and employee’s contribution till the 31st of March 2021 will be free from taxation.
- The interest earned on excess contribution will only fall under taxation when the employee’s yearly PF investment is more than Rs. 2,50,000.
- As the contributions made to PPF are already restricted to Rs. 1.5 lakhs per annum, the new amendment will not have any impact on the PPF investments.
What Made the Government Take This Step?
The Central Government has notified about the tax implication on EPF contributions after noticing some employees parking considerable amounts in these funds. Given that the interest rate provided in EPF funds is comparatively high than other savings instruments that promise guaranteed returns, it prompts employees to invest more to gain more interest.
Moreover, falling under the EEE mechanism also makes the Employee PF a feasible option to park one’s money. However, this, in turn, has made it difficult for the government to pay interest on such massive amounts. So, the government has proposed making this move and stopping people from saving excessively in EPF accounts.
How will the Interest be Taxed?
According to the proposal, the interest will be taxed in how the interest accrued on fixed deposits is taxed. No clause of double taxation has been put forth in the announcement. Moreover, the interest will be accountable to TDS (Tax Deducted at Source) as per Section 194(a) by the EPFO, which manages the EPF. More rules regarding the tax implications are awaiting clearance by the government.
Important Points to Note
- The interest income that is accrued by making an EPF contribution of more than Rs. 2.5lakh will be applicable for taxation under “Income from Other Sources”. It is because this income is not emerging from an employee-employer relationship.
- Moreover, the interest above the set limit will be counted as part of the employee’s total taxable income.
- As no rates have been specified by the government, the interest will be taxed as per the prevailing income tax rates.
The new proposal will not cause any problem for employees whose monthly contribution is within Rs. 20, 833. Therefore, employees falling in this category need not worry about any tax implications. However, people who earn a basic monthly salary of Rs. 1.75 lakh will not be able to escape taxation on the interest accrued. For more information regarding the taxation rules, get in touch with FinGurus, today!