Union Budget 2021 proposed to tax interest received on annual provident fund contributions above Rs 2.5 lakh. That would have a huge impact on high income earners due to EPF returns in the next financial year. If the EPF and voluntary provident fund (VPF) contributions cross Rs 2.5 lakh, the tax on interest will be the same as the individual’s income tax rate (including surcharge, if any).
Employees’ Provident Fund (EPF) is a retirement scheme under Employees’ Provident Fund Organization (EPFO) in India. In this, employer and employee both contribute a certain percentage of employee’s salary and employee gets lump sum amount of both contribution (employer and employee) at retirement along with interest. Employers contribute 12% of the basic salary plus dearness allowance and deduct an additional 12% on behalf of the employee. Income Tax Deduction under Section 80C is available for EPF contributions up to Rs 1.5 lakh per annum.
Read Also: Everything about EPF Registration for Employer
Voluntary Provident Fund (VPF) is a retirement account on a par with EPF. Employers do not contribute to it, but employees can voluntarily contribute to it. No tax deduction under section 80C is available for VPF contributions. However, VPF is attractive to some. This is because VPF earns the same interest as EPF and that interest is also tax-exempt (on contributions up to Rs 2.5 lakh post Union budget 2021). Some employers have also set up exempted PF trusts for their employees. These act as a proxy for EPF and earn the same interest and have the same tax status.
How was EPF taxed Earlier?
EPF has earlier enjoyed as EEE (exempt-exempt-exempt) status. Under Section 80C, contributions are tax deductible up to Rs 1.5 lakh a year. Interest from EPF, VPF, and exempted PF trusts is tax-free (up to Rs 2.5 lakh for staff contributions post the budget).
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Why Tax on EPF Interest introduced in budget?
Many high-earners were investing a lot of money into the EPF and receiving tax-free interest every year. Now, the tax deduction on employee contributions up to Rs 2.5 lakh a year has been capped in the Union budget, affecting employees earning more than Rs 20.8 lakh per year. For instance, now if an employee earns Rs 30 lakh and contributes Rs 3.6 lakh to EPF, the interest earned on Rs 1.1 lakh becomes taxable at the slab rate. Interest on contributions of up to Rs 2.5 lakh would stay exempt.
Are there alternative investment options?
Tax experts say falling yields from EPF will push investors towards other instruments like National Pension Scheme (NPS) or equity mutual funds. In NPS taxpayers can claim an additional Rs 50,000 deduction under Section 80CCD.
In other words, an employee earning a high salary may have to adopt a mix of EPF and NPS to maximize returns and minimize tax outgo. Returns on NPS are tax-exempt until withdrawals are made from the account upon maturity. At this point, 60% of the corpus is tax- free while 40% must be used to buy an annuity, which is taxable. While not EEE, this tax structure may work out to be more favourable than the taxation at slab rate that EPF interest on contributions above Rs 2.5 lakh will be subjected to.
Read Also: National Pension Scheme (NPS) in India
The author of above article is Riya Thawani.
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