Amongst the various Budget proposals, the one that is causing the most confusion and controversy is the proposed move to tax part of the provident fund proceeds. The following is a brief gist of what’s going on.
Under the existing provisions of the Income-tax Act, tax treatment of Recognized Provident Funds (RPFs) is Exempt, Exempt, Exempt (EEE) – the monthly PF deduction from salary is allowed as a deduction from income for tax purposes; the returns generated on these contributions are also exempt from tax and the terminal benefit (withdrawal of PF) on superannuation / retirement, in the form of lump sum is also tax-free.
However, in the case of the National Pension System (NPS) under Sec. 80CCD, the tax treatment
is Exempt, Exempt and Tax (EET) i.e., the monthly/periodic contributions during the pension accumulation phase are allowed as deduction from income for tax purposes; the returns are exempt from tax; however, the terminal benefits on exit or superannuation, in the form of lump sum withdrawals, are taxable in the hands of the individual subscriber or his nominee in the year of receipt of such amounts.So in order to bring greater parity in tax treatment of different types of pension plans and in a bid to move to what the FM calls a “pensioned society”, it is proposed that out of contributions to one’s PF made on or after the 1st of April, 2016, up to 40% shall be exempt from tax.
The balance 60% if withdrawn as a lump sum will be taxable. However, if this 60% remaining corpus is invested in an Annuity, no tax is chargeable.
In other words, the entire corpus will apparently be tax free, if invested in annuity.
There is an ambiguity here. While the 60% corpus if used to buy an annuity is tax-free, what it means is that there is no tax on the 60% lump sum per se (that is being invested in the annuity). In other words, the full 60% may be used to purchase the annuity. However, what the government hasn’t clarified is whether the annuity amount per se would be taxable or not.
In terms of an example, let’s say for an employee, the accumulated provident fund corpus (contributed after April 2016) is say Rs. 40 lakh. Now, if he / she were to withdraw the entire Rs. 40 lakh, then only 40% (Rs. 16 lakh) would be tax-free and the balance 60% (Rs. 24 lakh) would be taxable at slab rates (essentially at 30%).
However, if this Rs. 24 lakh is used to buy an annuity, then it will not be taxable – the entire Rs. 24 lakh can be invested in the annuity product. But now we go a step further. Let’s say Rs. 24 lakh is used to buy an annuity of say Rs. 16,000 per month – will this monthly income of Rs. 16,000 be taxable?
Though the authorities haven’t clarified this point per se, other annuities (purchased using superannuation funds or even private pension products) are fully taxable as per the current tax laws. If we draw a similar inference, then the annuity purchased using the PF proceeds (Rs. 16,000 in our example) will be fully taxable. It has been clarified that when the (ex) employee investing in the annuity passes away the original corpus will be fully tax exempted in the hands of the nominee.
Incidentally, similar changes are being ushered in for NPS too. Under the existing provisions of section 80CCD, any payment from NPS to an employee on account of closure or his opting out of the pension scheme is chargeable to tax.It is proposed to provide that any payment from NPS to an employee on account of closure or his opting out of the pension scheme referred to in Section 80CCD, to the extent it does not exceed 40% of the total amount payable to him at the time of closure or his opting out of the scheme, shall be exempt from tax. However, the whole amount received by the nominee, on death of the assessee shall be exempt from tax.
Note that PPF continues to remain tax-free so far. There is no change in the existing tax treatment of Public Provident Fund (PPF).As per a clarificatory note issued by the government, the purpose of this reform 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. The idea seems to be to tax the retrials especially for highly paid employees of the private sector.
Monetary Ceiling on Employer’s Contribution Introduced.
Currently there is only a percentage ceiling (12% of salary) – there is no monetary ceiling on the employer contribution under EPF. Similarly, there is no monetary ceiling on the employer contribution under NPS, there is only a percentage ceiling of 10% of salary.
Now the Finance Bill 2016 provides that there would be an annual monetary ceiling of Rs 1.50 lakh on the employer contribution considered along with the percentage ceiling of 12% of employer contribution, whichever is less.
The aforementioned clarificatory note goes on to add that since the government has received representations from various sections suggesting that if the amount of 60% of corpus is not invested in the annuity products, the tax should be levied only on accumulated returns on the corpus and not on the contributed amount.
Representations asking for removing the monetary limit on the employer contribution under EPF, in line with the NPS treatment have also been received.
The Finance Minister would be considering all these suggestions and taking a view on it Entire PF cannot be withdrawn anymore.
Lastly, though not related to the Budget per se but germane to the topic under discussion, apparently if you were to resign or change employment, you cannot withdraw your entire PF funds if you so desire!
As per a recent notification (GSR 158E dated 10th Feb, 2016) an employee can only withdraw his contribution and the interest thereon upon ceasing to be an employee – the actual wordings are “(1) The Central Board, or where so authorised by the Central Board, the Commissioner, or any officer subordinate to him, may, on an application made by a member in such form as may be specified, authorise payment to him from his provident fund account not exceeding his own total contribution including interest thereon up to the date the payment has been authorised on ceasing to be an employee in any establishment to which the Act applies.”
We are told employers are taking this to mean that this clause will get attracted to any cessation of employment other than retirement – however – it so happens that retirement is also a kind of cessation!! Anyway, be that as it may, the fact remains that not only will you get taxed, you won’t even get all your money back.
And who’s going to run the actual numbers?? – determining the return on only the employee’s contribution and not the employer’s could prove to be nightmare!! Watch this space for updates.
(The authors may be contacted at wonderlandconsultants@yahoo.com
