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EPF tax may return in new packaging
March, 10th 2016

The controversy over it may have settled down for now, but the employees’ provident fund (EPF) tax will likely return with a different name and approach. The central government is now figuring out the mechanics of levying the EPF tax on people who earn higher salaries, according to two government officials who requested anonymity.

And this time, the tax will be well-deliberated, well-planned, and the government ready with a plan to effectively mitigate any backlash, they added. Indeed, it won’t even be called a tax.

The idea is to achieve, at least for this segment of individuals, some parity between EPF and the National Pension System.

The budget proposal was for a straightforward tax on withdrawals from the EPF.

“The aim is to create a pension society, and pensions are always taxable,” said the first official. “We have the mechanism to make this happen and it’s being worked on.”

This fits in with what the finance minister said in Parliament on Tuesday as he withdrew the tax on EPF. “There are various other suggestions, which can also achieve the same policy objective of encouraging people to join the pension scheme,” Jaitley had said.

So, how will it be done?

The mechanics

An employee currently pays 12% of his basic salary towards EPF. An equal contribution is paid by the employer.

In the case of people earning below Rs.15,000 a month, from the employer’s contribution, around 30% (or 3.67% of the 12%) mandatorily goes to the EPF and the rest (8.33%) goes to the employees’ pension scheme (EPS) run by Employees’ Provident Fund Organization (EPFO).

This is based on the logic that these not-so-well-paid employees will need some form of regular income, through pensions, after retirement.

The government is likely to suggest that this apply to people earning above a certain base—probably not Rs.15,000 a month because it doesn’t want to be the target of the middle-class ire again, but, say, Rs.1 lakh or Rs.2 lakh a month.

While the employee’s contribution of 12% is taxed beyond Rs.1.5 lakh a year and is part of the Section 80C exemptions, the employer’s contribution of 12% is tax-free on the entire amount.

This works to the benefit of the well-paid, white-collar workers, said the first official.

How?

They do not pay tax on the employer’s contribution, the official said, adding that someone who earns Rs.1 crore a year (cost-to-company, which means the provident fund contribution of the employer is also factored in) actually ends up getting Rs.12 lakh of this pay tax-free.

“This is where the change will be brought in,” the official said.

This person added that these people will be asked to opt for having 8.33% of the employer’s contribution now go to the EPS and 3.67% to the EPF. In addition, 12% of their basic pay will go to the EPF as their own contribution.

Effectively, this means that a little over a third of the total contribution (8.33 of 24) will go to the pension scheme.

If they don’t opt for this, the 8.33% will be taxed. If they do, then pension earnings are taxable at the rate of individual tax slab. Either way, the government gets more tax than it does now out of them.

According to the finance ministry, 30 million of the 37 million subscribers of the EPF earn less than Rs.15,000. The remaining 7 million actually contribute more than 55% of the annual accrual to the EPFO. The government believes this includes a significant number of people who can be taxed because they are well-heeled.

The first official said that the government will decide on the salary threshold, and a decision will be taken only after consultation with the labour ministry, which was not consulted before the controversial budget announcement that had to be rolled back.

“The group of ministers dealing with labour reforms will hold discussions with stakeholders and explain the proposals but only after the state elections in April and May,” the official said.

The government seems to have garnered some support from the trade unions that have been criticizing the government over labour reforms.

“The intention of pension was good, but the method used was not good at all. EPF tax was a bad decision in an overall good budget with a rural focus,” said Virjesh Upadhyay, general secretary, Bharatiya Mazdoor Sangh, a central trade union affiliated to the ruling Bharatiya Janata Party.

Union labour minister Bandaru Dattatreya said the withdrawal of the EPF tax was a pro-people move after “government discussed the pros and cons of the budget announcement”.

He declined comment when queried on whether this reprieve would be temporary and if the tax would be coming back in any other form.

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