Starting from April 1st, the interest on employee contributions to new provident fund tax rule of over ₹2.5 lakh per annum will be taxed, finance minister Nirmala Sitharaman announced in the Union Budget 2021.
New Provident Fund Tax Rule
Up to ₹2.5 lakh has been kept as the deposit limit for which interest is tax exempt, finance minister said. In Finance Bill 2021, the government has introduced an amendment to the rule.
The finance ministry increased the deposit threshold limit to ₹5 lakh per annum in provident fund for which interest would continue to be tax-exempt, if there is no employer contribution. At least 12% of an employee’s basic salary and performance wages is compulsorily deducted as provident fund, while the employer contributes another 12%.
How is provident fund taxed?
“In order to rationalise tax exemption for the income earned by high income employees, it is proposed to restrict tax exemption for the interest income earned on the employees’ contribution to various provident funds to the annual contribution of ₹2.5 lakh,” Sitharaman said during Budget 2021. The central government later increased the limit on taxation of interest to ₹5 lakh, in cases where the employer is not making any contribution to the fund.
“The new provident fund tax rule increasing the tax free interest on PF contribution of upto Rs. 5 lakh would provide some respite to the large tax payers. However, this has come with a rider wherein the increased limit is applicable only in cases where the employee has contributed to a fund in which there is no employer contribution. In most of the cases, employees voluntarily increase their contribution to the same fund in which employer contributes their share,” clarified Divakar Vijayasarathy, founder and managing partner, DVS Advisors LLP.
This new provident fund tax rule will affect the high-income earners and High Net-worth Individuals (HNIs). Anyone who earns more than ₹20.83 lakh a year will attract his or her interest on EPF contribution being taxed. “The government has justified this move by stating that around 93% of the contributors gets covered under the ₹2.5 lacs limit itself and it is only the large tax payers who are outside this limit,” said Vijayasarathy.
“It may be noted that the new provision only takes into account employees’ contribution and not the total contribution to the fund during any year,” said Gaurav Saraf, partner, VPTP & Co. The salaried employees who use Voluntary Provident Fund to invest more than mandatory 12% of basic pay, will also be impacted. “A large tax free interest accrual which is not taxed on withdrawal either, is now being rationalised and will mostly impact the high income bracket,” said Archit Gupta, founder and chief executive officer, ClearTax.