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Aug 11, 2011, 04.41 PM | Source: Moneycontrol.com

Private Provident Fund Trusts: Issues and Challenges

In 1952, the Indian Government introduced a mandatory savings scheme for non-government employees known as Employees’ Provident Funds Scheme (‘EPFS’). In this scheme, employees and their employers are required to make a contribution to the Employees’ Provident Fund.

Private Provident Fund Trusts: Issues and Challenges
By: Parizad Sirwalla, Executive Director, Tax KPMG and Rambir Dalal, Associate Director, Tax KPMG

In 1952, the Indian Government introduced a mandatory savings scheme for non-government employees known as Employees’ Provident Funds Scheme (‘EPFS’). In this scheme, employees and their employers are required to make a contribution to the Employees’ Provident Fund.

The Government has also permitted employers to establish and manage their own private PF schemes, subject to certain conditions prescribed under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (‘EPF Act’). One such condition was that such private PF trust were required to seek approval under the Income-tax Act, 1961 (‘Income-tax Act’) for employees to get tax benefits.

The private PF schemes seemed to be more appealing as money remained with the in-house trust formed by the employer.  The employees also gained from the tax benefits which were at par with the statutory provident fund scheme as well as speedier settlement of their claims on retirement/ resignation.  It has been reported that there are approximately 2,750 private PF trusts with an estimated corpus of Rs 1 lakh crores and a membership of 50 lakh employees.

Approval of Private Provident Funds

Approval for setting up an in-house trust under the EPF Act may be granted to an entity which wants to run its own private PF scheme for its employees. The entity makes an application to the Government, through the jurisdictional Regional Provident Fund Commissioner, to exempt it from the operation of the statutory provident fund scheme.

If the government is satisfied that the benefits provided to the employees under the private provident fund scheme are, on the whole, not less favorable than the benefits provided in the statutory scheme, then it may permit the entity to run its own scheme instead of the statutory scheme.

A private scheme can be formulated either for all the employees of the company or for a specified class of employees (e.g. managerial staff). The permission to entities to run their own PF scheme is however subject to a number of conditions. One of the important conditions relate to guaranteeing a rate of return on PF accumulations at par with the statutory scheme.

The entity is required to create a board of trustees for governance of the PF scheme and to ensure an arm’s length transactions between the entity and the trust. The entity is also liable to make good any loss caused to the trust by fraud, defalcation, wrong investment etc. The entity has to pay only an inspection charge of 0.18% of wages rather than the administrative charges of 1.10% of the wages. Therefore, there is a cost saving of 0.92% of the wages. Multiple units of an entity can also participate in a common provident fund trust.

Change in Income tax Act 

The Finance Act, 2006 inserted a condition that a private PF trust would be granted recognition under the Income-tax Act only after it had obtained an approval under the Provident fund Act.  This change was made to safeguard the accumulations of the employees and to provide synergy between the Income-tax Act and the EPF Act. 

Thus, first the PF trust needs to be approved by the EPF authorities and subsequently they would be required to approach the the income-tax authorities for approval to qualify for the various tax concessions under the Income-tax Act. The deadlines in this respect prescribed earlier had been subsequently extended on various occasion and the current deadline is 31 March 2012. 

This, inter alia, means that the PF trusts of various companies who do not obtain necessary approval from the PF authorities would lose the tax benefits that are available to recognized provident funds effective 1 April 2012.
The reason for the extension was the quantum of applications in the pipeline with the PF authorities that require speedy clearance to avoid any undue hardship to the companies and their employees.

Employee Provident Fund Organisation (EPFO) becomes the primary regulator of provident funds

After 31 March 2012, any private provident fund (which is eligible for tax benefits under the Income-tax Act) will need to be registered under EPF Act. Consequently, EPFO will essentially become the regulator for all private provident funds in India which are desirous of getting tax benefits. Even those establishments that are otherwise not required to be registered under the Act may have to seek coverage under the Act. There is a possibility of voluntary coverage under section 1(4) of the EPF Act, if the establishment is not statutorily coverable under the EPF Act.

Potential issues and challenges

The process of getting an approval for setting up a private PF trusts from the EPFO and the Income tax authorities is a time engaging process. It may take approximately one to two years to get the necessary approvals. Once the private scheme is established, the employer has to match the rate of interest declared by the EPFO which may prove a difficult task for smaller companies.

EPFO is reported probable defaults from some exempt trusts as the sponsoring companies may have become sick. The employee retirement savings may become endangered in such cases. Timely detection of such defaults and speedy cancellation of approvals becomes critical to safeguard the interests of the affected employees. In conclusion, the employer has to take a considered decision after evaluating the cost and benefits of private trusts vis-à-vis using the Government Fund.

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