Employees having a basic salary up to approximately Rs 1.75 lakh per month would not attract tax on their interest earnings in PF.
The proposal to tax interest earned on provident fund (PF) contributions has left many employees perturbed. In her budget 2021 announcements, the FM has proposed that the interest earned on employee’s contribution above Rs 2.5 lakh in a year will become taxable in the hands of the employee. As of today, the entire PF contribution earns tax-free return and the PF amount enjoys EEE status. But, from April 1, 2021, the taxation of PF contributions will see a change. The interest earned on contributions above Rs 2.5 lakh per annum will be taxable as per one’s tax slab similar to how interest income from bank fixed deposit is taxed.
Should it leave you worried? Yes, if your contribution exceeds Rs 2.5 lakh in a year, the advantage of earning a tax-free return on the entire PF balance will be lost now. “Employees having basic salary up to approximately Rs 1.75 lakh per month would not attract tax on their interest earnings on PF. Those who earn beyond that Rs 1.80 lakh or more as basic salary per month would get impacted. Also, those who contribute additional in VPF and their total contribution exceeds Rs 2.5 lakh, the interest earnings would also get taxed,” says Prashant Singh, Business Head – Compliance and Payroll Outsourcing, TeamLease Services.
The tax will be on the interest earned on PF amount exceeding Rs 2.5 lakh in a year. The Finance Bill states – “The interest income accrued during the previous year in the account of the person to the extent it relates to the amount or the aggregate of amounts of the contribution made by the person exceeding two lakh and fifty thousand rupees in a previous year in that fund, on or after 1st April 2021.”
There could be two ways in which your contribution will exceed the cut-off limit of Rs 2.5 lakh. The PF tax calculation will be as follows:
1. Based on Basic Salary
2. Based on your voluntary contribution in voluntary provident fund
Based on Basic salary: Generally, 12 per cent of Basic Salary goes into the PF account each month. So, if your monthly Basic Salary is Rs nearly 1.75 lakh ( just the basic salary and not your total monthly income), your monthly contribution is nearly Rs 20833, which is Rs 2.5 lakh in a year. Nothing changes for you and interest earned on entire PF balance remain tax-exempt. The new PF contribution rules will not impact an employee whose monthly contribution is below Rs 20,833. However, if your Basic Salary is above Rs 1.75 lakh, there’s no escaping tax on interest earned. The only way out is if your employer provides you with an option to divert contribution to NPS.
Based on your voluntary contribution: Some employees contribute more than the mandatory 12 per cent towards PF. The PF rules allow that but it is not mandatory for the employer to match that additional contribution. They do so to earn a safe and tax-free return on their additional contributions. For example, for someone with a Basic Salary of Rs 1 lakh, the monthly contribution is Rs 12,000 which is about Rs 1.44 lakh in a year. The employee contributes an additional 12 per cent into VPF taking the total contribution to Rs 2.88 lakh in the year. In such a case, the interest earned on Rs 38,000 (Rs 2.88 lakh less Rs 2.50 lakh) will now get taxed.