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How interest earned on EPF contributions is taxed

The new tax rules prescribe that any interest credited to the PF account of an employee shall be tax-free in case of contributions up to Rs 2.5 lakh every year.

How interest earned on EPF contributions is taxed
As per the amendment, two threshold limits of the exemption have been introduced.

With an amendment in the Finance Act, 2021, interest earned on a provident fund (PF) balance has come under the ambit of tax. This has been effective from April 1, 2022. Before the amendment, the interest earned on a PF balance was fully exempt from tax under Section 10 of the Income-Tax Act, 1961.

As per the amendment, two threshold limits of the exemption have been introduced: Rs 5 lakh for government employees (where the employer does not contribute to EPF) and Rs 2.5 lakh in the case of other employees (where the employer also contributes to EPF).

New tax rules

The new rules prescribe that any interest credited to the PF account of an employee shall be tax-free in case of contributions up to Rs 2.5 lakh every year. However, “any interest on the contribution of an employee of over Rs 2.5 lakh will be taxed in the hands of the employee. In case an employer does not contribute to the PF account of the employee, then the threshold limit applicable will be Rs 5 lakh of the contribution of the employee,” says Archit Gupta, Founder and CEO, Clear.

For calculation purposes, the PF office or the employee’s PF trust will maintain two accounts under the main PF account as below:

* Contributions within the threshold (non-taxable contribution account), and

* For contributions exceeding the threshold (taxable contribution account)

Such accounts will be maintained from FY 2021-22 and for subsequent years.

The interest on the excess contribution will fall under the tax ambit and not the contribution itself. The balance in the EPF account as on March 31, 2021 will be part of the non-taxable account. Interest on the non-taxable account will remain tax-free like before.

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The interest accrued on taxable account will get taxed every year. The previous years’ accumulations in the taxable account will be carried forward to subsequent years. The interest accrued on the same along with the interest accrued on the contributions made during the yea will be taxed.

TDS Deduction on Taxable PF Interest

Tax will be deducted at source on such interest under Section 194A of the Income-Tax Act, 1961. As per this section, the payer of the income is liable to deduct TDS. Therefore, the provident fund office or the EPF trust will deduct the TDS.

In the case of resident Indians, the TDS rate applicable is 10% provided the PF account is linked with a valid permanent account number (PAN). Otherwise, it will be 20%.

However, the TDS will be deducted only where the interest amount is greater than Rs 5,000.

“In the case of non-resident Indians (NRIs), TDS will be deducted at 30% as per Section 195 of the Income Tax Act. However, if the rates stated under the Double Taxation Avoidance Agreement (DTAA) are beneficial, then such rates will be applicable. It is mandatory to link the PF account with PAN. Otherwise, the TDS rate applicable is 30%. Cess at 4% and surcharge at applicable rates are deductible with TDS on payments to non-residents,” says Gupta.

However, if the TDS is deducted as per the DTAA provisions, these charges are not applicable.

Tax Payable on PF Interest

Tax is payable on the interest credited in the taxable PF account during the year. Such interest should be included under the head ‘income from other sources’. Tax is to be calculated as per the applicable tax slab rates. An individual can claim the tax credit for the TDS deducted from the interest income.

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