The Cheat Sheet

Taxing interest on PF contributions— Soaking the salaried middle class

KR Srivats | Updated on February 11, 2021 Published on February 10, 2021

Is the government playing ‘Robin hood’ by taxing interest earned on employees’ contribution to provident fund?

One may tend to think so given that the axe of the Budget proposal to tax interest on contributions made to various provident funds are going to fall on seemingly small proportion of only well heeled PF subscribers from the salaried class.

What is the loophole that is being plugged?

The government certainly wants to plug a loophole (from equity perspective) where those who can contribute large amounts to these funds as their share are walking away with disproportionately high benefits.

So the Budget proposal is correcting a wrong in existing tax law of allowing blanket tax exemption without any thresholds, which those with super-duper salaries have been milking all these years! In Babu’s parlance, the government is closing the leakages in the pipeline that enabled people with high incomes not to pay taxes proportionate to that income.

So what does the Budget proposal mean to you and me as a member of the salaried class?

Well, if you are one who will contribute more than ₹2.5 lakh to your provident fund in a year beginning on or after April 1, 2021, the government wants to take away the current tax exemption that was available on interest arising from such contributions.

Simply put, the entire interest earned on your contributions (if contributions exceeds ₹2.5 lakh in a year) will be taxed.

When will the taxability arise — when my interest gets credited to my PF account at end of every financial year or at the time of its withdrawal?

The devil will be in the details and the guidelines are awaited from the CBDT on this. But if one were to go by the chatter in the corridors of power and views of tax experts, the taxability will arise at the time you withdraw the PF corpus, say on retirement.

So are my past contributions (prior to April 1, 2021) going to be ‘grandfathered’?

Yes. The government has been magnanimous and is not looking to bring to tax the interest you have earned or will be earning on past contributions. So in tax parlance, your existing contributions and the interest being earned on it will be ‘grandfathered’ from the Budget proposal.

Does this mean there is nothing ‘retrospective’ about this Budget proposal?

Well, thankfully there is nothing retrospective about it.

The government is keen on getting a slice (through tax) of your interest income from your future contributions to PF and provided such contributions exceeded ₹2.5 lakh in a year.

That’s great news, but what about this Lakshman Rekha of ₹2.5 lakh a year? Couldn’t the government have pegged it at say ₹5 lakh a year if it really wanted to net the big fish?

Going by the large number of representations reaching the doors of the Finance Minister, don’t be surprised if some tweak happens to this threshold when the amendments to the Finance Bill 2021 are moved in Parliament.

Is this Budget proposal then a revenue raising measure for the government?

It certainly is. The Revenue Department has done its math and are hopeful of making a tidy pile in tax revenues.

Otherwise why take the trouble of making changes to law etc and go to Parliament for this.

So what about disclosure of this income in the income tax return?

Well, if the taxability happens only at the time of withdrawal, then the interest income would have to be disclosed in the income tax return for that year in which the withdrawal is made. Hopefully, the CBDT would throw light on this aspect too in its guidelines, once the Budget gets passed in Parliament.

How many PF subscribers are likely to be impacted?

By one estimate, there are only 1.23 lakh persons out of Employee Provident Fund subscriber base of 4.5 crore who are earning more than ₹20 lakh a year (for the uninitiated statutory PF rate of 12 per cent gets you close to ₹2.5 lakh threshold now being prescribed). Now, when it comes to government provident fund (GPF), there is no cap on the quantum they can contribute and this Budget proposal will cover a larger section of government employees (mostly those who entered service prior to 2004).

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Published on February 10, 2021
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