Income Tax on Provident Fund: New Rule to tax PF contributions & interest

Income tax on provident fund: On August 31, 2021, the Central Board of Direct Taxes (CBDT) issued a notification making Provident Fund (PF) payments exceeding specific threshold limits, as well as the interest on such excess contributions, taxable beginning from April 1, 2022. Making PF taxable, which was previously a tax-saving tool, has left private-sector employees concerned and confused.

The Finance Act of 2021 stated that any interest relating to the amount of Provident Fund contribution paid by employees that exceeds Rs 2,50,000 is taxable. However, in circumstances where the employee is the only one contributing to the Provident Fund, the limit of Rs 2,50,000 would be increased to Rs 5,00,000.

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As a result of this amendment, the Provident Fund account would be divided two accounts, one for the Taxable component and the other for the Non-Taxable component.

In light of the amendment, the CBDT issued Notification No. 95/2021, which set forth the method for computing taxable interest on contributions to a provident fund or recognised provident fund that exceed the aforementioned threshold limit. Rule 9D requires that separate accounts for taxable and non-taxable contributions be kept inside the provident fund account, as follows:

1. Taxable Contribution -Taxable Component of the contribution (i.e. contribution exceeding the threshold limit) and interest accrued thereon

2. Non-Taxable Contribution–

Closing balance of EPF account as on 31st day of March 2021 plus Non-Taxable Component of the contribution and interest accrued thereon

3. Less: Any withdrawal from such account

The above-mentioned rule would apply to taxable and non-taxable contributions made by a person for the financial year 2021-2022 and all subsequent years.

The recently notified Rule 9D does not create much ambiguity; rather, it explains the taxable interest component computation mechanism. Furthermore, the requirement of separate accounts would add to EPFO’s complexity and compliance cost, as well as those of employers who manage their employees’ EPF accounts.

Example on Income Tax on Provident Fund

An employee having 10,00,000 in his EPF account makes a contribution of Rs 4,00,000 towards the EPF as well as the employer is making a similar contribution. In this case, the contribution would be bifurcated as follows:

1. Taxable Contribution

Rs 1,50,000 (4,00,000- 2,50,000) plus Interest accrued on Rs 1,50,000

2. Non-Taxable Contribution

Rs 12,50,000 (10,00,000 +2,50,000) plus interest accrued on RS 12,50,000

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How to pay Income tax on Provident Fund?

There are some questions about the employee’s responsibility to pay tax versus the payer’s responsibility to withhold tax in the form of TDS. The employee’s responsibility for tax payment differs from the payer’s responsibility to withhold tax.

Any person making a payment of accumulated EPF balance to any employee, provided the quantum of such payment exceeds Rs 50,000 and the money is payable to tax in the hands of the employee, was already liable to withhold tax under section 192A of the IT Act. As a result, such a requirement to withhold tax is not a result of the CBDT Circular recently issued, but is already contained in Section 192A of the IT Act.

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TDS certificate from EPFO

According to the IT Act, everyone who deducts TDS when making a payment to an assessee is required to issue a TDS certificate to that assessee within a certain time frame. This certificate serves as documentary evidence that the assessee can use to claim TDS credit while filing his income tax return. As a result, EPFO will be required to issue TDS Certificates to employees whose tax deducted or withheld.

How to save Income tax?

Before making investments, EPF subscribers who contribute more than the threshold limit should examine their investment strategy in light of the taxation of the excess contribution and consider other alternative investment choices.