New PF tax rule applicable from April 1: Here's everything you need to know

In Budget 2021, the government announced a restriction on tax exemption on PF contributions. The limit has been set for an annual contribution of Rs 2.5 lakh.

Put simply, if the employees’ contribution to the provident fund – statutory or voluntary – exceeds Rs 2.5 lakh a year, then the interest earned on this excess contribution will become taxable. The revised rule will come into force on April 1, 2021.

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Every month, at least 12 percent of an employee's basic salary and performance wages are compulsorily deducted as provident fund, while the employer contributes another 12 percent. With the new taxation rule, the government wants to curb high-income earners from availing of the tax benefit.

Until now, 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.

Read | EPF interest in tax net: Where should high-income earners invest for retirement now?

The move is likely to impact people with high income and hence, high contributions to EPF. The government has said that it will affect less than 1 percent of contributors.

Aside from high-income earners, salaried employees who use the Voluntary Provident Fund (VPF) to invest more than the mandatory 12 percent of basic pay, will also be impacted. Many subscribers invested in VPF as it provides the highest tax-free return on PF balance, backed by a sovereign guarantee.

Read | Tax on EPF interest: How will TDS be applied?

“The big-ticket money which comes into the fund and gets tax benefit as well as assured 8 percent returns would come under the tax ambit,” Finance Minister Nirmala Sitharaman had said in her Budget speech.

If an employee’s mandatory PF contribution itself is more than Rs 2.5 lakh a year, then there isn’t much choice. The new tax will be triggered automatically for the interest earned from contributions in excess of Rs 2.5 lakh, and for such persons, there is no option but to pay the tax.

However, those who have voluntarily contributed more than 12 percent of their basic pay through the Voluntary Provident Fund (VPF), can re-assess and lower the contribution to stay tax exempted.