Taxability of PF interest on contributions above Rs 2.5 Lakh

The Union Budget 2021 spared the high-income earners from levying any additional cess due to COVID, but on the other hand, have tried to bring one of the famous tax havens used by high-income earners into the taxability bracket. To save tax, high-income earners tend to park bulk monies in EPF/VPF accounts to enjoy the benefits of the E-exempt, E-exempt, and E-exempt class of investments. The investments, income earned and maturity proceeds in these PF accounts have remained exempt under sections 10 (11) and 10 (12) until this Budget 2021. 

The Finance Minister announced interest income earned on PF contributions above Rs 2.5 lakh annum to now be taxable. As per its straightforward interpretation, interest received on contributions to Employee Provident fund or Voluntary Provident funds exceeding Rs 2.5 lakh shall be taxable. Here, please note that the interest component only on the excess contribution is made taxable. Contributions continue to be allowed as a deduction under section 80C up to a ceiling of Rs 1.5 lakh. Also, Public Provident Fund (PPF) contributions will not be included here as the current laws do not allow contributions in excess of Rs 1.5 Lakh in a given financial year.  

Regarding interest taxability of EPF, reverse calculations state that an employee drawing a basic salary up to Rs Rs 20.84 lakh will not have to pay tax on PF interest as his yearly contributions would not surpass the threshold of Rs 2.5 lakh.  

For instance, an employee drawing a salary of Rs 22 lakh, will have an annual contribution to PF of Rs 2.64 lakh out of which interest earned on the excess contribution over Rs 2.5 lakh, i.e. Rs 14,000 will become taxable. Considering an assumption of an interest rate of 8%, interest payout would be Rs 1120, and a 30% tax on this income would be around Rs 336. The tax outflow would get higher if the amount of investment is much higher above Rs 2.5 lakh. 

Also, the employees earning low salaries but who tend to save more money in VPF will have to bear the tax on the additional interest.  

Here, the question arises, how will this limit of Rs 2.5 lakh applied for TDS purposes?

CBDT is yet to provide formal calculations of the taxability of the interest earned on contributions above Rs 2.5 lakh. 

However, CBDT officials have clarified that contributions to Employees’ Provident Fund (EPF) and Voluntary Provident Fund (VPF) above Rs 2.5 lakh a year will be kept in a separate basket and taxed similarly as fixed deposits, without any double taxation.  

As the bank deducts 10% tax on the interest that is accrued on fixed deposits, the same way TDS would become applicable on interest on excess contributions. 

If the taxpayers’ tax slab is higher than 10% then they will be liable to pay advance tax, but taxpayers get a refund if the tax liability is less than 10%.

What is the alternative investment option for high-income earners?

An employee earning a high salary can choose to adopt a combination of EPF and NPS to maximise returns and minimise tax outgo. NPS returns are tax-exempt except at the time of withdrawals upon maturity. Also at maturity, 60% of the corpus is tax-free while 40% is mandatorily converted into an annuity, which is taxable as salary income. Though NPS is not an EEE scheme, one can evaluate the tax benefits available in NPS vs tax on PF interests and possibly choose a mix of these. 

For any clarifications/feedback on the topic, please contact the writer at jyoti.arora@cleartax.in

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