India?s largest retirement fund, the Employees? Provident Fund Organisation (EPFO), has strongly protested with the government against the draft Direct Taxes Code that has proposed taxing retirement savings at the time of withdrawal. Arguing that the move could boost the mutual fund industry at the cost of social security, the EPFO has sent a missive to labour and employment secretary Prabhat C Chaturvedi, who is expected to take up the issue with the finance ministry.

The EPFO members currently enjoy a fully tax-free treatment on their contributions, the interest income and when accumulated savings are withdrawn, at the time of retirement. In tax parlance, this is known as EEE treatment (Exempt-Exempt-Exempt). The draft Direct Taxes Code proposes to introduce the Exempt-Exempt- Taxation (EET) system for such savings, whereby contributions and earnings thereon are exempt from tax but all withdrawals would be taxed at the applicable personal rate of tax.

The EPFO has argued that this would be against the principles of natural justice and equity for the 4.7 crore workers under its coverage. ?Our mandate is to cover people earning up to Rs 6,500 so their annual income would be Rs 78,000, which is much below the basic exemption limit for income tax?Rs 1.5 lakh. So those workers never got the benefit of the first exemption,? a senior EPFO official told FE.

?The interest income for a person with Rs 78,000 income, who contributes 24% of that towards EPF, would add up to around Rs 1,600. Even this income is far below the taxable threshold and so the worker doesn?t really partake of the exemption benefit at this stage,? the official added.

?When a worker has not taken the benefit of the first two exemptions, how can you tax him at the time of withdrawal? This is a basic flaw. Sure, the idea is to tax consumption, but you can?t put someone who availed the tax sops on par with someone who never did,? the official stressed.

A move to the EET regime would also make the EPFO an unattractive parking place for a large affluent chunk of the workforce that contributes more than the mandatory PF contribution into the scheme on a voluntary basis. Even new economy firms like Infosys Technologies have several employees who leave their money parked in the EPF despite changing jobs. ?Such investors will move to the mutual fund industry,? the official said.

The EPFO has reservations about another clause in the Direct Taxes Code that proposes to make the Pension Fund Regulatory and Development Authority (PFRDA) the nodal agency for deciding which retirement savings schemes are eligible for tax benefits. Before the code proposed EET treatment for all retirement savings, the PFRDA had been demanding parity in tax treatment with the EPF.

?The PFRDA Act is yet to be passed. Even if it is passed, how can it override another central law? EPFO?s operations are also mandated by Parliament. This will pose a legal problem,? the EPF official said.

Apart from triggering a nebulous turf war, the EPFO has stressed that the Code will create a massive administrative headache for the 57-year old organisation, especially due to the cut-off date till which investments will enjoy the old EEE tax treatment. The Code has set March 31, 2011, as the cut-off date for the taxation changes, so neither the balances retirement accounts like EPF on that date nor the earnings on that balance will be taxed at retirement. All fresh contributions from April 2011 will be taxed at withdrawal.

?The natural corollary of this is that we have to maintain two accounts?one upto March 31, 2011 and another after that. We already struggle to maintain 4.5 crore accounts. How can we administer 9 crore accounts? It?s a huge administrative burden,? the EPF official said.