Though tax benefits for contribution to the Tier I NPS account are available to all subscribers, tax benefits in respect of the Tier II account are available only to the Central government employees with three years lock-in period.
Before we discuss the taxation rules for the Tier II account under the National Pension System (NPS), let me briefly touch upon the types of accounts under NPS. One can have two type of accounts under NPS. First is the Tier I account, which is the main account and is also called pension account. The second is called Tier II account, which is like your savings account where you can deposit and withdraw money as and when you want. You can also transfer money from the Tier II account to the Tier I account and not vice versa.
Though tax benefits for contribution to the Tier I NPS account are available to all subscribers, tax benefits in respect of the Tier II account are available only to the Central government employees with three years lock-in period. In this article I wish to explain how the withdrawal from the Tier II account should be taxed. Let us discuss the same.
Are withdrawals from Tier II NPS account taxable?
Section 10 (12A) of the Income Tax Act exempts up to 60% of the amount withdrawn on closure of the account or at the time of opting out of scheme referred to in Section 80CCD. Likewise, Section 10 (12B) exempts upto 25% of the contribution made by an employee on partial withdrawal from the scheme referred to in Section 80CCD. Section 80 CCD obliviously refers to the tier I account as the deduction for contribution under Section 80 CCD is available for contribution made towards the Tier I account only and not the Tier II account. There is no direct reference to the Tier II account under Income Tax Laws except under the newly-introduced sub section of Section 80C(2)(xxv).
There is no direct provision for taxation of withdrawal of the Tier II account in the Income Tax Act. The tax laws cannot contemplate and provide for all the possible situations. If tax laws do not provide for taxation of any specific item, it does not by default means that it should invariably be taxed fully or is to be treated as tax-free. So, such a situation should be understood and decided logically and with common sense. The law makers would not have contemplated to tax an amount at the time of withdrawal if no tax benefit has ever been claimed at the time of deposit/investment of such money. The withdrawals from the Tier II account are like your regular withdrawals from your savings bank account which are not taxed except to the extent of interest credited in the account.
I draw my support from provisions of Section 80CCC. Section 80CCC(1) provides for tax benefits in respect of the premium paid for annuity purchased by an individual. Section 80 CCC(2) provides for taxing surrender value of such a policy. However, this section restricts the taxable portion to the extent to which the tax payer has claimed tax benefits under Section 80 CCC(1) and not beyond that except the accretion to the investment.
How the withdrawals should logically be taxed
Due to the reasons explained above, I am of the strong opinion that by no stretch of imagination the entire money on withdrawal from the Tier II account can be taxed. What can be taxed logically is the appreciation, if any. Since the investment made in the Tier II account does not carry any fixed rate of return like fixed deposits or bonds or debentures, the appreciation cannot be taxed under the head “Income from other sources”.
Moreover as you are allotted units for each portion of different category of equity and debts, it is very easy for you to compute profits with reference to the cost of units used for withdrawal. The difference between NAV of purchase date and redemption date has to be multiplied by the number of units used for redemption to arrive at the profit on realised on redemption.
Since investment in NPS can neither be called listed equity shares nor can be treated as units of equity mutual funds, the investment shall become long term only if the units are held for 36 months or more. As no Securities Transactions Tax (STT) is paid at the time of redemption, the same will not be taxed as equity-oriented schemes even in respect of your equity component and will be taxed at flat 20% after indexation if held for more than 36 months. If the units are redeemed before 36 months, the profits realised shall be treated as short-term capital gains.
Please note that what is stated here is not the legal provision in absence of any specific provision in the Income Tax Act, but is purely my opinion arrived at by applying common sense and sheer logic, and may therefore be appreciated accordingly. In view of the confusion surrounding tax on withdrawal for the tier II account, the government should ideally make the legal position clear as soon as possible. This will help many people to take the decision to avail the benefit of the low cost investment avenue.
(The writer is a tax and investment expert, and working as Chief Editor of ApnaPaisa. He can be reached at Balwant.firstname.lastname@example.org)
Disclaimer: The views expressed in this article are personal.