[Editorial Analysis] An ambiguous levy: On tax on PF incomes

Mains Paper 3: Economy
Prelims level: Employees’ Provident Fund Organization
Mains level: Government Budgeting: Inclusive growth and issues arising from it.

Context:

• Finance Minister has stressed that Budget 2021-22 raises resources to push the economy without increased taxation. The Budget had said that interest on employee contributions to provident fund over Rs 2.5 lakh per annum would be taxed from April 1, 2021.

• For this one change to the income tax law proposed in the Finance Bill, 2021, has triggered anxieties for the salaried class: withdrawing tax exemption on interest income accrued into Provident Fund accounts arising out of employee contributions exceeding Rs.2.5 lakh ‘in a previous year in that fund,’ on or after April 1, 2021.

The Employees’ Provident Fund Organization (EPFO):

• The Employees’ Provident Fund and Miscellaneous Provisions Act, 1952, under Ministry of Labour & Employment) Is government organization that manages provident fund and pension accounts of member employees.

• It is one of the World’s largest Social Security Organizations in terms of accounts of member and the volume of financial transactions undertaken.

The Employees Pension Scheme (EPS):

• The social security scheme, provided by EPFO from 1995, that’s makes provisions for pensions for the employees in the organized sector after the retirement at the age of 60 years.

• Both employer and employee contribute 12% of employee’s monthly salary and Employees who are members of EPF automatically become members of EPS.

The rationale behind this tax:

• The rationale some employees are contributing huge amounts into their PF accounts and getting tax-free incomes.

• The Revenue Department has pointed out the tax will only affect a small group of ‘high net-worth individuals’ (HNIs).

• The social security scheme for formal sector workers should become an investment tax haven for the well-heeled corporate top brass.

Tax treatment inequity:

• This is not the first time this government had tried to tax PF savings, citing its abuse by the rich. In the 2016-17 Budget, it proposed to tax 60% of EPF balances at the time of withdrawal, but backtracked after a backlash.

• Now, it has covered even government employee’s contributions into the GPF, but left NPS investments over Rs.2.5 lakh a year untouched.

• Tax treatment inequity between India’s limited retirement savings instruments aside, employees and employers have some serious doubts on the implementation.

• The words ‘in a previous year’, for one, suggest this will be a type of retro-active tax taxing future income even on past years’ contributions of over Rs.2.5 lakh.

• It is also not clear when and how the tax is to be paid at retirement or each year that the PF rate is announced.

• This may not be smart timing for a government looking to lean on huge borrowings to dent large inflows into EPF most of its corpus is captively deployed in government bonds.

Aimed at taxing high-value depositors in the EPF:

• Up to Rs.2.5 lakh has been kept as the deposit limit for which interest is tax exempt, finance minister said.

• At least 12% of an employee’s basic salary and performance wages is compulsorily deducted as provident fund, while the employer contributes another 12%. Anyone who earns more than Rs.20.83 lakh a year will attract his or her interest on EPF contribution being taxed.

• If employee’s contribution to provident fund on or after 1 April 2021 exceeds Rs.2.5 lakh in any year, interest earned on contribution over Rs.2.5 lakh shall be taxable.

• But at the same time, getting tax exemption and 8% rate of interest for somebody who puts Rs.1 crore into the account, we thought is may be not correct. And therefore we have put the ceiling,” finance minister said.

• The big-ticket money which comes into the fund and gets tax benefit as well as assured about 8% returns that would come under the tax ambit.

Conclusion:

• While the goal of targeting high net worth individuals (HNIs) using the PF savings to avoid taxation is laudable, the Centre should consider recalibrating the arithmetic and operational details of this tax.

• If an employee and an employer are in agreement to allocate share of their total earnings for the provident fund purposes then EPFO should provide full benefit of the same to the employee.

• The financial burden of the pension on the government is huge. Investment avenues for the EPFO need to be increased so that government is able to provide pensionary benefits to the people. Formation of a separate organization specifically for the investment purposes can also be considered.

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