EPF is mandatory for all employees earning more than Rs. 15,000 and working in an organization with over 20 employees. EPF was one of the most efficient retirement and tax planning schemes. The employer’s contribution was completely tax-exempt, and interest earned from EPF was tax-free without any restrictions.
EPF amount is deducted from your salary on a monthly basis by your employer. It accumulates in your EPF account, which you can access after retirement. You can use the EPF calculator to estimate the EPF amount based on your salary.
But in Budget 2021, Union Finance Minister introduced Sections 10(11) and 10(12) in the Income Tax Act 1961 that would make interest earned taxable.
Employees contributing to EPF can claim tax deductions u/s 80C of the IT Act 1961. This tax benefit is limited to Rs. 1.5 lakh. In the earlier tax regime, an employer’s contribution of up to 12% was tax-free.
Any contribution over 12% was taxable. Furthermore, the interest income earned by EPF account holders was tax-free.
In Budget 2021-22, the Government of India amended the IT Act to make interest earned on EPF taxable. This is applicable for employees contributing more than 2.5 lakh every year to EPF.
The main aim of this provision was to bring high-income earners that contribute significantly to the scheme from getting undue benefits.
However, when there is no employer contribution, as is the case for government employees, individuals can contribute up to Rs. 5 lakh without being taxed. Interest earned only on excess contributions above the prescribed threshold will be taxed, not the total contribution.
The PF trust that maintains all EPF accounts will now keep these accounts under two categories—taxable and non-taxable. Taxable are those whose contributions exceed Rs. 2.5 lakh, and no tax is levied on contributions below the threshold.
Another change introduced is that the employer’s contribution in NPS, EPF, and superannuation funds exceeding Rs. 7.5 lakh will be taxable in the hands of employees.
One can use this formula to calculate non-taxable contributions:
The aggregate of the following:
(A) Closing balance in EPF account as of March 31 2021, any contribution by employee below Rs. 2.5 lakh or Rs. 5 lakh as the case may be in the new financial year, interest accrued on the closing balance and interest received on contributions below the limit.
(B) Any withdrawal from these accounts.
Non-taxable contribution = (A-B)
Aggregate of the following:
(A) Any contribution made by an individual over and above the threshold limit of Rs. 2.5 lakh or Rs. 5 lakh as the case may be in the financial year, interest accrued on such contributions in the financial year.
(B) Withdrawal from these accounts.
Taxable contributions = (A-B)
One can find an individual’s taxable contribution using this formula.
Only the contribution made by employees over and above the threshold will come under the taxation net. The tax burden will fall on the employee with a PF account. As per calculations, only those earning more than Rs. 20.83 lakh will be affected by this rule change. Therefore, only selected sections of high-income earners will have to assess the effect of the new provisions.
The Government of India, while introducing this new rule, categorically mentioned that it aimed to prevent high-income earners from contributing significantly more than their mandated contribution to EPF annually. Many high-income earners use this approach to reduce their tax liability.
CBDT has introduced a new section in Income Tax Rules 1962 to execute this new rule.
The government has changed the rule to broaden the tax base and mop up higher direct tax collections. This may help the tax administrators to plug a loophole in tax laws used by many to avoid taxes. People must find alternative investment avenues offering tax deductions and stable returns to maintain their disposable income.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.