Finance Minister Nirmala Sitharaman announced in Budget 2021 that interest on employee contributions of over Rs 2.5 lakh per annum to the provident fund would be taxed, starting from 1 April. Annual contributions up to Rs 2.5 lakh has been kept as the deposit limit for which interest is tax exempt.

Note that every month, at least 12% of an employee's basic salary and performance wages is compulsorily deducted as provident fund, while the employer contributes another 12%. With this taxation, the government wants to curb high income earners from self contributing more to their PF accounts.

Expenditure Secretary T V Somanathan had said earlier that the number of people who actually contribute more than Rs 2.5 lakh is less than 1 per cent of the total number of contributors in the EPF. "In order to rationalise tax exemption for the income earned by high-income employees, it is proposed to restrict tax exemption for the interest income earned on the employees' contribution to various provident funds to the annual contribution of Rs 2.5 lakh," Sitharaman said in her Budget speech. 

This move will affect mostly the high-income earners and High Net-worth Individuals (HNIs). Under the existing tax provisions, interest received/accrued from employee’s provident fund (EPF) is exempt from tax. The new rules will potentially impact employees in high income bracket or employees making large voluntary employee provident fund contributions.

Remember that the new provision only takes into account employees’ contribution and not the total contribution to the fund during any year. "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," the finance minister said.

Aside from high-income earners, salaried employees who use Voluntary Provident Fund (VPF) to invest more than mandatory 12% of basic pay, will also be impacted. A large tax-free interest accrual which is not taxed on withdrawal either, is now being rationalised and will mostly impact those in the high income bracket. The method of calculation will be specified later as the taxation details have not yet been shared by the government.

Meanwhile, around 4 million subscribers of the government’s pension scheme Employees' Provident Fund (EPF) are yet to receive interest payments even after one-and-a-half months of the government announcing the payout for 2019-20.   The delay occurred due to a mismatch of KYC or identification of the employees at the employer’s end.  The field offices of the Employees’ Provident Fund Organisation (EPFO) are reaching out to the employers