As the entire withdrawal amount is taxable, each component of the withdrawn amount - the employer contribution, employee contribution, and respective interest on these contributions - needs to be reported separately.
Divya Baweja and Mitesh Agrawal
The Provident Fund (PF) is a highly preferred retirement saving scheme among employees. Under this scheme, both employee and employer contribute a fixed portion of pay (12 percent each). Every year, interest at a notified rate is credited to the cumulative balance of the Fund and at the time of retirement or pre-retirement withdrawal, total contributions made by the employee and employer are paid along with the accumulated interest.
The PF scheme enjoys an EEE status i.e. the contribution, accretions and the withdrawal on retirement are exempt from taxation, subject to certain conditions. The contribution made by an employee also qualifies for a deduction u/s 80C of the Income-tax Act, 1961 (Act), within the overall ceiling limit of Rs 1.5 lakh.
Before retirement, an employee is permitted to withdraw the PF amount for specified purposes such as marriage, education, purchasing a house or medical treatment, etc. Withdrawal of accumulated PF balance is also allowed in case an employee remains unemployed for a continuous period of 2 months, on retirement or on death/ incapacitation of the employee.
At the time of withdrawal, the accumulated balance of PF may be taxable or exempt from tax depending upon the total number of years for which the employee was in continuous service.
Withdrawal made before five years of continuous service will attract taxation. On withdrawal, the employee will get accumulated balance comprising of employee contribution, employer contribution, interest on employee contribution and interest on employer contribution; taxability of each of these components will occur in the year of withdrawal and varies from each other.
For the employee contribution, deduction u/s 80c claimed in earlier years will be disallowed and employees will have to pay tax at the same rate at which tax would have been paid in those years. The employer contribution, interest on the employee contribution and interest on employer contribution will be taxed as income of the year in which the withdrawal is made.
As the entire withdrawal amount is taxable, each component of the withdrawn amount - the employer contribution, employee contribution, and respective interest on these contributions - needs to be reported separately. The employer contribution and the interest earned on the employer contribution need to be categorised as “Salary Income”. The reversal of deduction u/s 80C of the Act of employee contribution and interest earned on the employee contribution will be categorised as “Income from Other Sources”.
Withdrawal made after years of continuous service is exempt from tax. While interest up to cessation of service is exempt, the interest earned on the accumulated balance post cessation of service (i.e. the period between the date of termination/ retirement of service and the date of actual payment/settlement of fund) will be taxed in the hands of the employee.
Though the amount so withdrawn will not be taxable, however, it would need to be reported as ‘Exempt’ income in the “Exempt Income Schedule” of the income-tax return. The interest earned on the accumulated balance post cessation of service is taxable and has to be reported as “Income from Other Sources” in the income-tax return.
With increased governance and scrutiny by the revenue authority for correct taxability and disclosure in the income-tax return, the taxability and reporting of withdrawal of PF are a crucial part of the income-tax compliance by an individual. It is pertinent to report the income carefully in the income-tax return so as to avoid any unforeseen impact at a later date.Author Divya Baweja is Partner, Deloitte India and Mitesh Agrawal is Manager with Deloitte Haskins and Sells LLP.The Great Diwali Discount!
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