The Budget has been the hot topic of discussion considering the proposed taxes on the Employee Provident Fund (EPF). Uncertainty created by the language of the provisions and the proposal to tax EPF at withdrawal has not been welcomed by the public.
An additional deduction of Rs 50,000 was introduced in the previous Budget for individuals investing in National Pension System (NPS). However, NPS did not receive the desired investment because a better option was available in form of EPF, which offered a tax-free sum at withdrawal as against NPS. Let’s look at the proposed changes in both the schemes and its impact.
To move towards a pensioned society, the current Budget proposed changes not only to the taxability of NPS but also the EPF, which was taking the sheen away from NPS. To bring parity in both the schemes, the FM proposed restricting the tax exemption to 40% of accumulated balance attributable to contributions made with effect from April 1, 2016 by an employee to EPF.
On the other hand, NPS, which was fully taxable at withdrawal, is now proposed to be tax exempt up to 40% of the total amount payable at closure. Where the provision exempting NPS is clear, the language used for EPF provision created confusion whether the entire corpus or only the employee contribution along with interest should be considered for this clause. Further, in order to incentivise purchase of annuity at retirement instead of withdrawal of entire corpus, it is proposed to make the EPF corpus used to purchase annuity exempt from tax. Similar provision was already in place for NPS.
In response to the public uproar, the government clarified that 40% of the corpus withdrawn would be tax exempt and the balance 60%, if invested in annuity, would also be tax-free. Let’s examine the possibilities of receiving annuity from the funds and whether it reaches the recipient ‘tax-free’.
If one chooses to purchase annuity at the time of withdrawal from EPF or NPS, it is only the conversion that would be tax exempt. The annuity received (monthly, quarterly or annually) would be taxable as salary income and at applicable rate in the taxpayer’s hands. Hence, at the time of retirement, where an individual may not have any other major source of income, he may end up paying taxes on the annuity received.
There are various annuity schemes available in the market – some allow pension to continue to family members for an agreed period and some may pay the corpus to the legal heir in the event of taxpayer’s death. A new provision has been proposed to exempt the corpus in the nominee’s hands in the event of the taxpayer’s death.
There are no changes proposed in the Budget for taxability of annuity received by the taxpayer’s spouse or any other family member. Hence as per the existing provisions, annuity received by the taxpayer’s family members would be taxable in their hands. Therefore, even if the spouse or other dependent family members do not have any other source of income, they may have to pay taxes on the annuity if it exceeds the minimum threshold, currently at R2.5 lakh (R3 lakh for senior citizens).
Considering the discontent among the middle class employees due to the proposed amendments and the Prime Minister’s recommendation, the FM is likely to reconsider the decision of taxing EPF corpus.
The writer is tax Partner, People Advisory Services, EY With inputs from Navneet Golchha, senior tax professional, EY