National Pension System: Higher NPS contribution enhances tax liabilities of state govt employees

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Updated: Jun 05, 2020 2:28 PM

The Central Government had announced an increase in its contribution from 10 per cent to 14 per cent to the NPS Accounts of its employees from the last financial year.

income tax, tax deducted at source, TDS, tax challan, National Pension System, NPS, additional contribution to NPS, tax on additional NPS contribution, goverment employees, tax rebate u/s 80CCD(2) on employer's contribution to NPSThe provision of employers’ contribution to NPS u/s 80CCD(2) has been increased to 14 per cent for Central Government employees only.

Hemendra (name changed), a teacher of a government school in Uttarakhand, was shocked after getting a challan from the school authority, asking him to pay additional tax over and above the tax deducted at source (TDS) from his take home salary. Against his query, the school authority informed him that the additional tax liability has arisen due to the increase in the State Government’s contribution from 10 per cent to 14 per cent to the National Pension System (NPS) Accounts of the employees.

After the Central Government announced an increase in its contribution from 10 per cent to 14 per cent to the NPS Accounts of its employees from the last financial year, many state governments, including that of Bihar, Himachal Pradesh, Karnataka, Maharashtra, Punjab, Uttarakhand etc have also enhanced the employers’ NPS contribution to 14 per cent.

“With effect from 1 April 2020, the government enhanced the employer’s contribution in case of Central Government employees to 14 per cent. To bring the tax deduction on par, in the Finance (No. 2) Act, 2019 the limit on the tax deduction for the contribution was also enhanced to 14 per cent from FY 2019-20 (AY 2020-21). Under the new limit, a Central Government employee can claim the entire employer’s contribution of 14 per cent as a tax deduction under section 80CCD(2). Salary for the purpose of contribution includes basic salary plus dearness allowance,” said Archit Gupta, Founder and CEO – Cleartax.

Earlier, both the government and its employees used to make an equal contribution of 10 per cent of basic salary and dearness allowance (DA) to the NPS accounts of each employee.

However, the provision given u/s 80CCD(2) of the Income Tax Act says, “Contribution made by employer shall also be allowed as deduction under section 80CCD(2) while computing total income of the employee. However, amount of deduction could not exceed 14 per cent of salary in case of central Government employees and 10 per cent in any other employees.”

So, the provision of employers’ contribution under section 80CCD(2) has been increased to 14 per cent for Central Government employees only.

“The Government has increased its contribution for its employees to Tier-1 NPS account from 10 per cent to 14 per cent and, in addition to this the income tax exemption for employer’s contribution under section 80CCD (2) has also been enhanced from 10 per cent to 14 per cent. But, this is only applicable to the Central Government employees,” said Pranjal Kamra, CEO, Finology.

“It means that for those employed with the state governments and PSUs, the tax rebate is applicable only to the extent of 10 per cent of the employer’s contribution. So, the rest of 4 per cent will be borne by the employees themselves thereby increasing their tax liability (as it would form a part of their income),” he said.

Confirming that any increase in employer’s contribution, other than the Central Government, would result in additional tax liability, Gopal Bohra, Partner, NA Shah Associates LLP, said, “In line with the Central Government’s announcement to increase contribution to national pension scheme (‘NPS’) from 10 per cent to 14 per cent, certain state government (like Punjab Government) has also increased their contribution to NPS from 10 per cent to 14 per cent. In order to give full deduction of enhanced contribution to Central Government employees, Finance (No. 2) Act, 2019 has amended section 80CCD(2) to increase the limit of deduction from 10 per cent to 14 per cent from AY 2020-21. Thus, the entire 14 per cent contribution made by the Central Government to NPS is deductible from taxable salary.”

“However, there is no such change in case of increased contribution made by state government, therefore, the additional 4 per cent contribution made by the state government to NPS will be considered as part of salary and employee will require to pay tax on increased contribution unless the provision of section 80CCD(2) is amended,” he added.

So, unless section 80CCD(2) is amended to extend the tax rebate on 14 per cent contribution by other employers as well, employees, other than Central Government employees, will end up paying higher tax on higher than 10 per cent contribution by their respective employers.

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