FinMin notifies rules for taxing interest on PF: Know what it means

Indian rupee
A man displays new 2000 Indian rupee banknotes after withdrawing them from a State Bank of India (SBI) branch in Kolkata, India, November 10, 2016. Reuters/Rupak De Chowdhuri/Files

New Delhi: The Finance Ministry has notified rules for calculation of taxable interest on employee contributions to provident fund of over Rs 2.5 lakh per annum.

In her Budget for 2021-22, Finance Minister Nirmala Sitharaman had capped the tax-free interest earned on provident fund contribution by employees and employers together to a maximum of Rs 2.5 lakh in a year in an attempt to dissuade high earners from parking their surplus in what is supposed to be the common man's retirement fund.

The Central Board of Direct Taxes (CBDT) on Wednesday notified rules for calculating taxable interest in provident fund.

It said for the sake of calculation, separate accounts within the provident fund account shall be maintained beginning 2021-22 for taxable and non-taxable contributions made by a person.

The new rule is that the interest earned on an employee's contribution above Rs 2.5 lakh in a year will become taxable in the hands of the employee while for the government sector employees, the monetary ceiling shall be Rs 5 lakh.

Employees' Provident Fund Organisation (EPFO) has over 6 crore subscribers.

The Rs 2.5 lakh limit covers around 93 per cent of the people who are EPFO subscribers and they will continue to get assured tax-free interest. Hence, small and medium taxpayers will not be impacted by the step.

Nangia & Co LLP Partner Shailesh Kumar said the notification issued by CBDT has finally put to end the ambiguity which arose with the introduction of taxation of interest on provident funds with contribution above the specified threshold.

Rule 9D inserted in the Income-tax Rules, 1962 has specified that separate accounts within the PF accounts shall be maintained clearing segregating the taxable and non-taxable contributions to PF along with interest thereon.

"This shall provide a convenience of calculation to the taxpayers for segregation of interest to be offered to tax. The threshold for PF accounts with employer contribution is Rs 2.5 lakhs whereas accounts with no employer contribution enjoy an increased threshold of Rs 5 lakhs," Kumar added.

How will it get taxed?

As per the notification, the interest income on the additional contribution (over Rs 2.5 lakh for private and Rs 5 lakh for government employees) for a year will get taxed every year. What this means is that if an individual contributes Rs 3 lakh every year to the provident fund (including the voluntary PF contribution) then the interest on his contribution above Rs 2.5 lakh — that is, Rs 50,000 — will be taxed. In that case, Rs 2.5 lakh will be credited to one account and the taxable Rs 50,000 will be added to another account. So, the former account will be non-taxable and latter will become taxable.

Will it get taxed for perpetuity?

This means that if your annual contribution to PF in FY22 is Rs 10 lakh, the interest income on Rs 7.5 lakh will get taxed not only for FY22 but also for all subsequent years. If the PF contribution is the same for FY23, the tax will have be paid on interest income on Rs 15 lakh. Also, if you earned interest of 8.5% last year, and if you fall in the highest tax bracket, then the following year you will earn effectively around 5.85% on the additional contribution (assuming the interest rate is unchanged).

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