‘Status' worry of provident funds

Rajesh Bhagat Jitendra Trivedi | Updated on February 20, 2011 Published on February 20, 2011

If provident fund gets de-recognised due to failure to obtain exemption under the PF Act, it could expose employers, employees and trustees to adverse tax consequences.

The establishments that have provident fund set up prior to March 2006 and enjoying recognition under the provisions of the Income-Tax Act, 1961 (‘the Act') may lose the status of being recognised provident fund if they failed to obtain exemption on or before December 31, 2010 from applicability of the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 (‘the PF Act').

The requirement to obtain exemption from the PF Act was introduced by the Finance Act, 2006 with the stated objective to provide legislative synergy between the Act and the PF Act.

The exemption was to be obtained by March 31, 2007 which time limit got extended more than once through annual budget exercise to provide adequate time to the Employee's Provident Funds Organisation to decide on the applications for exemption.

The last extension of statutory time limit was made up to December 31, 2010 (on earlier occasions extension was up to financial year-end) and as of date, the same has not been further extended.

Cause of concern

This could be a cause of concern for the employers whose applications have not been decided by the PF authorities by December 31, 2010 and also for the employers who have not applied for PF exemption at all (but covered by PF Act).

As per the provisions of the Act, the recognition to PF shall be withdrawn if exemption from the PF Act is not obtained by December 31, 2010.

However, failure to obtain exemption should not result in automatic withdrawal of recognition to PF as any such withdrawal could be by way of an order passed by the tax authorities (i.e. Chief Commissioner or Commissioner) and that too after providing a reasonable opportunity to the employer and trustees of the provident fund.

If PF gets de-recognised on account of the failure to obtain exemption under the PF Act, it could expose the employers, employees and the trustees to the provident fund (‘PF') to adverse tax consequences. In case of employers, the deduction would not be available for the contributions made to PF.

Employees would not enjoy exemption towards the employer's contributions and would not be entitled for deduction for their own contributions made to the PF. Also, the trustees would be liable (as representative assessees) to tax in respect of the income of the provident fund.

Lack of clarity

Further complications can arise as there is a lack of clarity as to whether de-recognition would be effective on prospective or retrospective basis.

As per the provisions of the Act, the order withdrawing recognition is to take effect from the date from which it is made by the tax authorities.

However, one of the rules prescribed by the Central Board of Direct Taxes (CBDT) requires that the accumulated balance to the credit of each employee at the end of the financial year prior to the date of such withdrawal of recognition shall be paid to him free of tax and the remainder of the accumulated balance due to him shall be liable to tax as if the fund had never been recognised.

Untested legal position

The CBDT prescribed rule goes to suggest that de-recognition is effective retrospectively in so far as the taxability of the sums received by the employees is concerned.

It is an untested position of law as to whether such rule prescribed by the CBDT is ultra vires insofar as it seeks to expand the scope of taxation by providing for retrospective effect of de-recognition in contrast to what is provided under the rules forming part of the statute.

Further, in case of resigned/retired employees who are already paid money tax-free, a question would arise as to how the retrospective effect of de-recognition would apply or take effect and a related question would also be as to whether the employer is under an obligation to deduct tax from the amounts so paid/payable to employees or is it the liability of employees to pay tax.

Further, in an extreme case, even the trustees of PF may be made liable (as representative assessees) to tax on retrospective basis in respect of the income of the provident fund.

Also, it will be a area of concern for employees as to whether they will be entitled for deduction under Section 80C of the Act for the contributions made by them during the financial year in which de-recognition of the provident fund takes place. Thus, the CBDT prescribed rule needs to be suitably amended to provide for scope of taxation in line with the provisions of the Act.

Time limit extension

The need of hour is also to extend the statutory time limit with effect from January 1, 2011 for the PF authorities so that the employers whose application for exemption were pending as on December 31, 2010 are not put to disadvantage.

As of now, the employers are left with limited options i.e. either follow up with the PF authorities on a consistent basis or consider the option to transfer the funds to Provident Fund account maintained under the PF Act.

This uncertain scenario calls for an immediate extension of statutory time limit which is possible only by way of an Ordinance being passed by President of India to this effect; else it may find its place in the forthcoming Budget.

(The authors are Senior Manager and Associate respectively of PricewaterhouseCoopers Pvt. Ltd).

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Published on February 20, 2011
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