Tax treatment of NPS makes it an attractive avenue

The National Pension Scheme (NPS) is a defined contribution scheme and operates under the guidance of the Pension Fund Regulatory and Development Authority (PFRDA). NPS carries a unique feature wherein subscribers can plan their investments according to their age and risk appetite. A subscriber has the flexibility to make contributions on a systematic basis, that is, monthly, quarterly, or annual.

Another key feature of the product is its low cost compared to other similar options. However, despite its low cost and flexibility, tax benefits and implications of NPS will decide how attractive it can be for investors in the long run.

Like any other pension plans, contributions made by an individual, would be eligible for a maximum annual deduction of R1 lakh under Section 80CCD, read with Section 80CCE ,of the Income-Tax Act, 1961. But what sets it apart from other pension schemes is the tax benefit it offers under Section 80CCD(2). Under this Section, contributions made by the employer up to 10% of the basic salary and dearness allowance towards NPS qualify as a deduction in the employee?s hands. The employer is also eligible for a corporate tax deduction on this contribution.

Hence, individuals in the higher tax bracket can save significant taxes. As these changes are beneficial to both employer and employees, some employers have started to offer NPS as part of the compensation structure.

Let?s understand it with an example of Prateek, who is a chartered accountant and his annual salary is R20 lakh. His employer contributes 10% of the salary (i.e., R2 lakh) to NPS and Prateek makes a matching contribution. Prateek will be eligible to claim a maximum deduction of R1 lakh out of his R2 lakh contribution. Employer?s contribution of R2 lakh will be eligible for deduction and, hence, will not be taxable for him. Employer will be eligible to claim R2 lakh contribution as a corporate tax deduction.

Tax at withdrawal: NPS requires you to compulsorily purchase an annuity so that you get some money in lump sum and the balance in annuity. Broadly, the lump sum and annuity are both taxable under the IT Act as NPS follows an Exempt-Exempt-Taxable (EET) concept.

Under the proposed Direct Taxes Code (DTC), NPS is proposed to be covered under the Exempt-Exempt-Exempt (EEE) regime wherein the employee would enjoy the tax benefits when contributions are made. The accumulations to the fund would continue to be tax-free and withdrawals from the fund are proposed to be exempt.

Schedule VI of DTC provides a list of income that will not be included in the total income of an individual which includes ?any payment from NPS Trust to an employee having an account with the trust under the NPS notified by the Central government?. Based on this reading, we can say that the lump sum withdrawal and annuity both are exempt from tax. However, it would be difficult to mention anything conclusive till DTC is finally implemented.

As the withdrawals are likely to happen in DTC era for most of the people, NPS can become an attractive investment opportunity.

The writer is a director with KPMG. The views expressed are personal