Two days after the budget, in the teeth of mounting opprobrium, the government appeared to be sticking to the plan of taxing 60% of EPF withdrawals. A day after the budget, the finance ministry came out with a clarification on exactly what this tax is, and why it was imposed. Here’s what it said:
* Only 40% of EPF withdrawals are tax-free, unlike 100% earlier.
* 60% of EPF withdrawal will be taxed as income if it is not invested in an annuity offered by an insurance company. However, the subsequent income stream from the annuity will be taxed.
* This taxation will apply only to whatever is put into an EPF account April 1 onwards, and the growth of that amount. Amount accumulated so far, and its further accumulation, will not be taxed at all.
A little backgrounder here. So far, EPF has been completely tax-free. In comparison, the National Pension System (NPS) has had a tax on withdrawal. Up till now, when an NPS member would retire, 40% of the accumulated money in the account has to be used to buy an annuity which will provide a pension. This money was not taxed at the time of the annuity purchase, but the resulting pension is taxed just like any other pension. The remaining 60% was taxable, in contrast to EPF. Now, they have both been brought to parity, as described above.
According to the official explanation, “The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account”.
This has not been made applicable to those earning less than R15,000 a month, presumably because the government thinks that it is OK for low-earners to squander their PF after retirement. The government has decided that the only way to do so is to make people buy an annuity, or face the threat of confiscation of a good part of their savings in the form of tax. This is a strange attitude, very much a throwback to the 1970s. This despite the fact that annuities available in India are a very poor deal, with effective returns around 6-7% pre-tax. This is less than the inflation rate, and top of that, the payouts will be treated as income. Like much of India’s insurance product roster, annuities are a robbery, but that doesn’t appear to have bothered the government.
Another big problem is that this tax will treat the accumulation of savings as income. When you encash your holdings from any long-term capital assets like mutual funds and real estate, then the principal amount is not taxed, and the gains are treated as capital gains. Long-term capital gains are either not taxed if held for a certain period (one year for equity and equity funds) or taxed after adjusting for inflation (for everything else). However, the proposed tax will simply add it to the savers’ income. EPF returns are barely above inflation rates. To disallow indexation for inflation is grave injustice. This is morally and principally wrong. Moreover, because this tax will be on bulk withdrawals, it will push even low-income savers into the 30% tax bracket for that year. This is unconscionable.
If the real purpose of this ‘reform’ is really to prevent people from squandering their PF kitty, then it should be taxed as capital gains, and then some other more efficient kind of withdrawal option given to save the tax. To force every retiree into one specific, low-quality method of getting a regular income is the worst possible way to achieve the stated purpose, even if the stated purpose is true.
The author is CEO, Value Research