Budget 2021 has left income-tax rates and slabs unchanged. But it found way to tax the rich and super rich by taxing the interest earned on Employee’s Provident Fund (EPF) contributions in excess of Rs 2.5 lakh in a financial year.
While we await further clarifications from the finance ministry on how exactly the interest would be computed and taxed, here’s a glimpse of how it may be operationalised.
Also read: The complete Moneycontrol EPF Guide
What portion of my Employee’s Provident Fund (EPF) contribution is taxable?
Back-of-the-envelope calculations show that if your annual basic salary is close to Rs 21 lakh (Rs 1,73,612 a month, to be precise) or more, you will come under the EPF tax net. Remember, just the interest on the excess contribution will be taxed; not your contribution itself.
For example, if your annual basic pay is Rs 22 lakh, you would have contributed Rs 2.64 lakh (12 percent) to EPF – Rs 14,000 above the annual Rs 2.5-lakh threshold. Assuming 8.5 percent payout – which was the interest rate on EPF for the financial year 2019-20 – the interest earned on the ‘excess’ Rs 14,000 will work out to Rs 1,190.
If you fall in the 30 percent tax bracket, you will have to pay a tax amount of Rs 371 (30 percent plus 4 percent cess, but no surcharge) on this sum.
Those who earn low salaries but choose to invest a significantly higher proportion in EPF through VPF (voluntary provident fund) will also be hit by the EPF tax.
How will the interest earned on my PF contributions over Rs 2.5 lakh be taxed?
First, the formal rules on computation are yet to be issued. But initial indications are that taxpayers would need to add the interest accrued every year to their income-tax statements.
Central Board of Direct Taxes (CBDT) chairman PC Mody has indicated that the interest on excess PF contribution will be taxed in a manner similar to that of bank fixed deposit interest. “The interest portion is calculable on a year-to-year basis, and that will go on an accrual basis, so that is taxable on your calculations in that particular year. If I am contributing into the GPF [General Provident Fund for government employees], I know how much interest I have received that year. That should be brought to tax in that very year. That is very simple, it’s just like bank interest,” he said.
How do you calculate the excess interest on which you need to pay taxes, every year?
It is likely that your provident fund statement will make the bifurcation clear.
“Whatever contribution you are making to Provident Fund, whatever is in excess of ₹2.5 lakh, which will be in a separate basket and interest on that particular corpus will be taxable. But it will work exactly in the same manner as the way interest income on fixed deposits is taxed today,” said Kamlesh Varshney, joint secretary, tax policy division at the Central Board of Direct Taxes (CBDT) at a post-Budget industry event, according to media reports.
Banks deduct 10 percent tax (TDS; tax deducted at source) on the interest that is accrued on fixed deposits. If the taxpayers’ tax slab is higher than 10 percent then they pay advance tax, but taxpayers get a refund if tax liability is less than 10 percent, he is reported to have said. But the bifurcation that Varshney has referred to could be tough, say experts.
“The PF statement displays one consolidated figure of interest earned on the balance in the account which includes your contribution as well as that of your employer. Segregating the interest on employer’s contribution and employee’s contribution along with bifurcation between interest earned on the contribution beyond and under the Rs 2.5 lakh threshold will have to be provided to the employee so he can comply,” says Archit Gupta, CEO and Founder, Cleartax.
So, will TDS be deducted every year on the interest on employee’s PF contribution of over Rs 2.5 lakh?
Fixed deposit interest is treated as ‘Income from other sources’. Tax at the rate of 10 percent is deducted on the interest before it is credited, unless you fall in the exempt category. This is likely to be the case with interest on excess PF contribution too. “The TDS on deposits is 10 percent, hence the same should apply. It should be deducted by the payer – the provident fund department – and not the employer,” says Sudhir Kaushik, Co-founder and CEO, Taxspanner.
Again, the procedure would be clear only after the finance ministry and CBDT officially notify the rules.
But what about interest-on-interest from excess contribution? Will it be taxed in future years too?
This is a point of confusion – even tax experts differ on this aspect.
“If you have invested, say, Rs 3 lakh in EPF in 2021-22, then the interest earned on Rs 50,000 (Rs 3 lakh less Rs 2.5 lakh) is taxable in 2021-22 - and only in that particular year, not in the subsequent years. The rest remains tax-free,” says Adhil Shetty, Co-founder and CEO, Bankbazaar. The exemption is linked to the contribution threshold of Rs 2.5 lakh, not interest income and, therefore, the tax will come into the picture only in the year it is breached, is the rationale.
However, some tax experts contend that tax will be applicable in subsequent years too. “Even if your contributions exceed Rs 2.5 lakh only in one financial year, the interest earned on this excess contribution is taxable in all future years too,” says Kaushik. Again, this will be clear only after the rules are notified.