The proposed tax on Provident Fund interest has come like a bolt from the blue for high-income earners and HNIs who squirrel away huge sums into this taxfree haven. Though the tax will kick in only on contributions above Rs 2.5 lakh a year and will apply only to contributions by the employee, many Provident Fund subscribers are upset
This is not the first time that the government has proposed to tax Provident Fund money. The 2016 Budget had proposed that the interest accrued on 60% of the EPF be taxed. The proposal was rolled back after a massive outcry against the new levy. However, this year’s proposal may not face as big a backlash because it affects only the creamy layer of salaried employees. Finance Ministry officials estimate that less than 1% of Provident Fund subscribers will be affected. The Rs 2.5 lakh annual threshold means that a person contributing up to Rs 20,833 a month to the Provident Fund (basic salary Rs 1.73 lakh a month) will escape tax.
While it is true that very few subscribers have a basic salary of more than Rs 1.73 lakh a month which puts their 12% contribution to the Provident Fund above the Rs 2.5 lakh tax-free threshold, it is equally true that a significant number of salaried employees use the Voluntary Provident Fund to invest more than the mandatory 12% of basic pay.“The proposed tax will hit high-income salaried people who use the Voluntary Provident Fund to earn tax-free interest,” says Amit Maheshwari, Partner, Partner, AKM Global.
PF contribution may get hikedThe new Wage Code adds another complexity to the issue. The new Wage Code, which comes into effect on 1 April, has laid down that the basic salary has to be at least 50% of the total income of the individual. This means salary structures will have to be rejigged with a higher basic salary, which will automatically increase the individual’s contribution to the Provident Fund.
Vikas Dogra contributes only Rs 2.4 lakh to the Provident Fund right now so he won’t be affected. But after the Delhi-based finance professional joins a new company in April, some portion of his Provident Fund contribution will become taxable. “The compensation structure under the new wage code means my basic pay will be close to Rs 2.5 lakh and yearly contribution to Provident Fund will be almost Rs 3 lakh,” says Dogra. With Rs 2.5 lakh of his contribution earning 8.5% and Rs 50,000 earning 5.85% post-tax returns (in the 30% bracket), his overall returns from the PF will come down to 8.06%.
Lower returns from PF
Like Dogra, subscribers with high salaries and those who contribute more than the mandatory 12% will earn lower returns on their Provident Fund. The bigger the contribution to the Provident Fund, the lower will be the return.
Financial experts are not exactly surprised by the move to tax the Provident Fund interest. “It is a tax anomaly. The change was long overdue,” says Amit Kumar Gupta, Portfolio Manager for PMS at Adroit Financial. Others feel that the tax will push investors to other, more lucrative options. “High income earners should not binge on fixed income. They should reduce the VPF contribution to Rs 2.5 lakh and invest the rest in NPS. They can claim additional tax deduction of Rs 50,000 under Sec 80CCD(1b) and potentially earn higher returns,” says Sudhir Kaushik, Co-founder of tax filing portal Taxspanner.com.
The new tax is another attempt by the government to rationalise the tax exemption enjoyed by high-income employees. Last year’s Budget had capped the tax exemption on employers’ contribution to Provident Fund, NPS and superannuation fund to Rs 7.5 lakh. While that impacted only employees with very high salaries, this year’s proposal has a wider impact.
PPF not included in Rs 2.5 lakh limitFor Provident Fund aficionados, there is some relief though. The government has clarified that the Rs 2.5 lakh limit will not include contributions to the Public Provident Fund (PPF). Many people were fearing that PPF contribution would be included in the Rs 2.5 lakh limit, which would have reduced the escape hatch for Voluntary Provident Fund contributions.
Investors who invest heavily in the VPF and are worried by the proposed tax should invest up to Rs 2.5 lakh in the Provident Fund and then go for the PPF where their investments will fetch higher returns and remain tax-free. Only if they have more to invest after exhausting the Rs 1.5 lakh annual investment limit in PPF should they go for VPF.
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