Unfair tax on savings

The 2021-22 Budget is notable for not imposing fresh taxes, but for one clause lurking in its fineprint. This is the plan to withdraw the tax exemption on the interest income earned by employees’ provident fund contribution exceeding ₹2.5 lakh a year. The Employees Provident Fund (EPF) is one of the very few savings products in India that still enjoy an exempt-exempt-exempt (EEE) regime, that is contributions, interest and withdrawals are all exempt from tax. The proposed change now may prove a significant deterrent to employees using it as their default retirement vehicle. While the memorandum claims that the cap became necessary because some employees were found to be ‘contributing huge amounts’ to their provident funds, the Centre ought to introspect whether this is such a bad thing.

The current generation of Indians is staring at a crisis of severely under-funded retirement given the country’s abysmal pension coverage, withdrawal of guaranteed pension for government employees and advent of National Pension System (NPS). As the government offers no social security cover to the retired or elderly, those working in the organised sector rely mainly on their own contributions to the EPF to build up a retirement kitty. This makes the repeated backdoor attempts to withdraw EEE benefits on EPF quite unfair, even if it impacts only 1 per cent of EPF members. After mooting and hastily withdrawing a tax on EPF maturity proceeds a couple of years ago, last year’s Budget brought in perquisite taxation for employers’ contributions to provident funds that exceed ₹7.5 lakh a year. While the new ₹2.5 lakh a year limit appears to be an attempt to curb benefits to a creamy layer of employees earning over ₹20 lakh a year, even those well below this threshold will fall into the net if they make high voluntary PF contributions. The clause’s wordings are also unclear on whether the tax will apply only to contributions made after April 1, 2021 or to interest on legacy investments as well. The argument that the EPF’s high interest is subsidised by taxpayers is debatable as the fund presently pays annual interest only out of its declared surplus. It is another matter that dodgy accounting often leads to its interest declarations being significantly higher than underlying portfolio returns. If the Centre wants to avoid the risk of taxpayers eventually being called upon to bail out the scheme, the focus must be on aligning EPF interest to its portfolio returns, with a changeover to accrual accounting, mark-to-market investments and unit accounts.

To help employees plan, the Centre must reveal its long-term roadmap for the three retirement vehicles (EPF, PPF and NPS) without attempting piecemeal changes. Higher-income folks can be persuaded to explore non-EPF avenues, if retirement accounts are carved out from the crowded section 80C and deduction is raised to, say ₹2.5 lakh. The compulsory annuity rule on the NPS must also be done away with.

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