Budget 2021: Interest income on annual EPF contributions above Rs 2.5 lakh to be taxed

Finance Minister Nirmala Sitharaman announced the proposal to restrict the tax exemption for the interest income earned on the employee’s contribution to various provident funds. The limit has been set for an annual contribution of Rs 2.5 lakh. This will be made applicable only to contributions made on or after April 1, 2021. The move will largely impact Voluntary Provident Fund (VPF) contributions.

Less than one percent of the contributors to EPF are expected to get hit because of this measure.

Excess contributions to be taxed

Put simply, if the employees’ contribution to the provident fund – be it statutory or voluntary – exceeds Rs 2.5 lakh per year, then the interest earned on this excess contribution will be taxable. Up until now, your contribution to provident fund had enjoyed a favourable tax treatment. So far, all contributions enjoyed tax shelter under section 80C (up to a maximum contribution of Rs 1.5 lakh). Interest accrued was tax-free and so were withdrawals. This has made the EPF a popular retirement saving tool. Under the EPF scheme, an employee has to make a certain contribution (12 percent) towards the scheme, and an equal contribution is made by the employer.

"This is likely to change the savings pattern of senior people in higher salary bracket and make them move towards other avenues such as NPS and also the common practice of companies doing PF deductions on full basic (or wages as defined in the new code) instead of capping at the wage ceiling," says Preeti Chandrashekhar, India Business Leader – Health and Wealth, Mercer.

However, employees also had the option of investing additional amounts through VPF. This was favoured, especially by high income earning individuals. With the introduction of this new restriction, large contributions to provident funds become unattractive. Given the threshold of Rs 2.5 lakh per year, it is expected to hurt only large contributions to provident fund.