Things to keep in mind while splitting the PF accounts from 1 April
Premium- One must understand the taxability of interest before reducing PF contribution
Employees Provident Fund (EPF or PF) is one of the few retirement savings schemes available to the organized sector with significant tax benefits and sovereign-backed returns, which is typically higher than most other fixed-income products. Tax exemptions are available on the contributions made, on the accruals as well as on the withdrawals (this triple taxation benefit is known as EEE or Exempt, Exempt, Exempt scheme).
With the objective to limit the tax benefits on PF to members who make high contributions, typically done through Voluntary Provident Fund (VPF), Budget 2021 had introduced the taxation of interest earned on employee contributions exceeding ₹2.5 lakh per financial year effective FY 2021-22. This applies only to contributions made by the employee and not the employer.
For cases where the employer does not make contributions to the employee’s PF, the threshold beyond which interest will be taxable is ₹5 lakh.
Practical aspects to be considered
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The Central Board of Direct Taxes (CBDT) had issued a notification last year explaining how this will work. The employee contributions will be segregated into two accounts holding taxable and non-taxable corpus. The taxable corpus would include employee contributions in excess of ₹2.5 lakh effective FY 2021-22 and the related interest as reduced by any withdrawals.
The credit of taxable interest also triggers withholding tax obligations, in respect of unexempted establishments. This would be the responsibility of the Employee Provident Fund Organisation (EPFO). However, organizations with PF Trusts would need to gear up to segregate the corpus and also meet the tax withholding obligations. The limit of ₹2.5 lakh is as per financial year effective FY 2021-22, and would include voluntary contributions as well. Interest accrued on such contributions would be taxable as “income from other sources" and would form part of the taxable corpus.
The interest accretions will be taxable even in a situation where the continuous service of the member with the employer exceeds 5 years.
Taxpayers have the option to offer to tax “income from other sources" on an accrual basis or on a cash basis. Accordingly, taxpayers would need to claim the taxes withheld in the relevant tax years in which the income is offered to tax.
Advance tax obligations are required to be kept in mind. Employees also have the option of declaring their personal income to the employer so that tax obligations on such income are adequately covered.
Pitfalls to be avoided
It is vital to understand the financial impact of the taxability of interest before deciding to reduce PF contributions.
One knee-jerk reaction from many employees could be to consider PF contributions as unattractive from a tax perspective and limit the contributions to the statutory wage ceiling of ₹15,000. This would mean that employee contribution is limited to ₹1,800 per month.
It is important to remember that employer contributions to PF are eligible for tax exemptions ( even under the simplified tax regime) and employee contributions are eligible for deduction u/s section 80C under the regular tax regime.
The table provides a comparative financial impact analysis where an employee decides to limit PF contribution to the statutory wage ceiling and chooses to pay taxes under the regular tax regime.
There are issues such as the approach to be adopted when an employee avails loan—whether to be adjusted from taxable or non-taxable corpus, whether true up to the withholding is required when the actual interest rate differs from that estimated during the year end, etc.
Currently, the rules do not cover these aspects except for the fact that two separate accounts would need to be maintained. EPFO/ CBDT may need to come up with further guidelines which could potentially provide clarification on these issues.
Saraswathi Kasturirangan is partner with Deloitte India. Prashanth G, manager with Deloitte Haskins & Sells LLP has contributed to the column.
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