Issues in Taxing PF contribution

Synopsis: By taxing the income of PF contributions over 2.5 lakhs, the government wants to restrict High net-worth individuals (HNIs) who are using the social welfare scheme as a tax haven. Though it is well-intended, it has many ambiguities.

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Background

• The Union Budget 2021 has proposed taxing the income on provident fund contributions of over Rs. 2.5 lakh a year from 01 April 2021.
• The rationale given for taxing the income from provident fund contributions is to target HNIs. They are using the PF savings to avoid taxation. For example, the 100 largest employees’ PF (EPF) accounts had a combined balance of over ₹2,000 crores.
• This is not the first time the government had tried to tax PF savings. In the 2016-17 Budget, the government proposed to tax 60% of EPF balances at the time of withdrawal. But due to protest from employees, it was withdrawn later.

What are the ambiguities in this scheme?

Revenue Department has pointed out that the tax will only affect a small group of HNIs. However, the scheme suffers from the following ambiguities,

• First, the threshold of taxing contributions of over Rs. 2.5 lakh is very low. It will end up taxing PF income for employees who are investing ₹21,000 a month towards their retirement.
• Second, the threshold proposed is also not in line with the ₹7.5 lakh limit. It was set in last year’s Budget for employers’ contributions into the EPF, National Pension System (NPS) or other superannuation funds.
• Third, it creates inequity between India’s limited retirement savings instruments. For example, it does not cover NPS investments over ₹2.5 lakh a year, but it includes government employees’ contributions into the GPF.
• Fourth, it is also not clear on when and how the tax is to be paid. Either at retirement or each year after the PF rate is announced.
• Fifth, The CBDT chief has said that employees should showcase PF income in their annual tax returns. But this may work for GPF members whose interest rate is announced every quarter. Not for EPF accounts, as interest rates are declared late and credited even later.
• Finally, this move will affect the fund flow into EPF. This will in turn hamper the government’s sources for finance which is largely dependent on market borrowings.