The Finance Ministry recently notified new income tax rules, under which the interest income that is accrued in a person’s provident fund will now be taxed. This rule applies to those who make PF contributions of over Rs 2.5 lakh a year.
What prompted this move?
This proposal to tax interest income on EPF contributions over a threshold was made in the Budget this year.
“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 Rs 2.5 lakh,” finance minister Nirmala Sitharaman had said in the Budget speech.
The view was that it may not be correct for someone putting even Rs 1 crore into the PF account to get a tax exemption and an interest rate of over 8 per cent.
According to reports, around Rs 62,500 crore was accumulated as PF of 1.23 lakh high net worth individuals with a Rs 103 crore accumulated in the account of the highest contributor.
The new rules in essence bring in the big money that comes into PF accounts under the tax ambit.
Who will be impacted and how?
Provident fund accounts under the Employee Provident Fund Organisation and the General Provident Fund for government employees will be impacted by the new rules.
For all the subscribers, two different accounts will now have to be maintained—one with taxable contributions and another with non-taxable contributions.
The amendment in the Income Tax Rules is effective April 1, 2022. Two separate accounts will have to be maintained each year starting 2021-22.
Non-taxable contribution account shall be the aggregate of the closing balance in the account as of March 31, 2021; any contributions made by the person in the account during the previous year 2021-2022 and subsequent previous years, which is not included in the taxable contribution account and the interest accrued.
Taxable contribution account shall be the aggregate of the contribution made by the person in the account during the previous year 2021-2022 and subsequent previous years, which is more than the threshold limit; and the interest earned on the contribution. Withdrawals if any will also be factored in.
If your contributions to the provident fund are over Rs 2.5 lakh, then the interest accrued on the contributions over the threshold will be taxed. For instance, if the contribution is Rs 4 lakh, then the interest income on Rs 1.5 lakh will be taxed. For the government employees, or in PFs where there is no employer contribution, the threshold has been increased to Rs 5 lakh in a financial year.
What should you do now?
If your PF contributions are less than Rs 2.5 lakh then not much will change for you and there may be no need to worry about the changes. Almost 93 per cent of the people who are EPFO subscribers fall below the Rs 2.5 lakh limit and their PF interest income will continue to be tax-free.
If your contributions are exceeding the threshold, or if you also contribute towards a voluntary PF, then perhaps you may want to reassess the same or assess the overall tax liability in consultations with your tax advisor. But, do remember the current interest rate of 8.5 per cent is much higher than on other small savings instruments or bank fixed deposits.
