The Budget has proposed significant changes on taxation of Employees’ Provident Fund (EPF). Given that EPF is at the core of the Indian social security system and is the only mandatory retiral benefit that is available to the salaried class, the proposed amendments have triggered a considerable amount of debate.
Current provisions relating to EPF
Employer contributions to EPF up to 12% of pay (as defined under the EPF Act) are tax free, no monetary ceiling has been prescribed.
Contributions made by the employee are eligible for a deduction (along with other specified investments) within the limit of R1.5 lakh per annum under Section 80C. Interest accretions to the EPF account are not taxed, to the extent these are inline with the interest rates declared by the EPFO. Withdrawals from the EPF account are not subject to tax where the employee has rendered continuous service of 5 years or more. In short, the EPF enjoys an exempt-exempt-exempt (EEE) status.
Two critical amendments are proposed with respect to PF contributions. A monetary ceiling is proposed to be introduced restricting the tax free employer contributions to
Rs 1.5 lakh a year, or 12% of salary, whichever is lower. The proposal introduces an exemption limit on withdrawal from EPF. As against the current 100% exemption on withdrawals, in respect of employee contributions, made on or after April 1, 2016 the proposal is to restrict the exemption to 40% of such accumulated balance. This proposal is currently being debated. Contributions and accretions prior to April 1, 2016, however, would not be impacted. The provisions relating to taxation of withdrawals would not apply to “excluded employees”.
The press release dated March 1, 2016 clarifies that employees with pay of less than Rs 15,000 per month would not be impacted.
Challenges and alternatives
Given that EPF is the primary retiral benefit of the salaried class, exemption for employer contributions were intended to encourage investments in EPF. Introducing exemption ceiling for employer contributions would ensure that the benefit of tax-free contribution continues to be available for contributions at least up to a reasonable limit. To illustrate, where an employee has a basic pay of Rs 80 lakh per year, the exemption available is currently at Rs 9.60 lakh per year. From the government’s perspective, having a tax exemption provision without a monetary ceiling is not desirable as these are not intended for the super-rich. The proposed ceiling of Rs 1.5 lakh a year, would trigger taxation where the ‘pay’ is more than R12.50 lakh per year.
Taxing the EPF withdrawals may result in double taxation and needs a closer reconsideration for ironing out such results. Employee contributions are made out of post-tax salary and taxing the same at the point of withdrawal triggers double taxation. While a deduction is available for such contributions under Section 80C, in reality the benefit may not be availed, given the low ceiling of Rs 1.50 lakh per annum and the multitude of investments permitted.
The press release of March 1, 2016 indicates that 40% of the total corpus withdrawn will be exempt. This implies that employer contributions may also be taxed on withdrawal up to 60%. This would clearly result in double taxation to the extent employer contribution is taxed in excess of Rs 1.5 lakh as has been proposed in the Budget.
Taxation of future employee contributions and accretions at the point of withdrawal would necessitate significant administrative processes to be in place.
Further, it is not clear how employees earning a pay of less than Rs 15,000 would be exempt from this provision. Would the taxation be triggered based on basic pay at the point of contribution or at the point of retirement? If it is the former, monitoring the year of contribution and the corresponding salary level would be a challenge. If it is the latter, the purpose of providing the exemption would be lost as it is likely that with annual increments, the salary levels will be over the ceiling of Rs 15,000.
Given the absence of a robust government supported social security system it is important that the government encourages investments in pension schemes.
However, requiring employees to transfer funds from EPF to National Pension System (NPS) may not be the solution. Specific provisions enabling allocation of EPF funds to the annuity service providers at the point of retirement can be provided for. It is also necessary that tax exemptions for such investments are provided for in the amendments. These would help India move towards a pensionable society.
* A monetary ceiling is proposed to be introduced restricting the tax-free employer contributions to Rs 1.5 lakh a year, or 12% of salary, whichever is lower
* Introducing exemption ceiling for employer contributions would ensure that the benefit of tax-free contribution is available for contributions at least up to a reasonable limit
* Taxing the EPF withdrawals may result in double taxation and needs a closer reconsideration for ironing out such results
* Given the absence of a robust government supported social security system it is important that the government encourages investments in pension schemes
The writer is a partner with Deloitte Haskins & Sells LLP. With inputs from Saraswathi Kasturirangan, director with Deloitte Haskins & Sells LLP