The government's decision to raise the interest rate on employees' provident fund (EPF) savings for 2010-11 to 9.5% while keeping the tax-free ceiling at 8.5% has made the 2,700 PF trusts run by Indian companies jittery over the tax treatment of last year's interest.

There is ambiguity over how the 1% differential between EPF rate and the tax-free ceiling should be treated while crediting interest to employees. If the Finance Ministry does not revise the ceiling to 9.5%, it would mark the first time that PF savings are subject to tax.

Industry chambers Assocham has urged the government to align the tax-free cap with the 9.5% rate after several corporate PF trusts raised the issue. "This decision seriously jeopardises salaried employees' interests, whose PF contributions are already under threat of value erosion due to high inflation in the country," Assocham said in a missive to the Central Board of Direct Taxes chairman.

The Employees' Provident Fund Organisation (EPFO) has been urging the Finance Ministry to revise the tax-free ceiling on PF savings in line with the 9.5% rate. But with no notification in sight two months into the new financial year, crediting the 9.5% interest to employees has become a tax risk for the 2,700 PF trusts managed by India Inc.

The EPFO has begun crediting interest to PF accounts without taxing the extra 1% interest over the notified ceiling. But company-run trusts are in a bind as they are subject to scrutiny from both the tax and the PF authorities.

"Some companies have started taxing workers on the extra interest over 8.5%, others have paid 8.5% and are hoping for the air to be cleared before crediting the rest," said an advisor to several corporate retirement trusts.

The problem has been compounded by the decision to stop interest credits on inoperative accounts (with no inflows for over 3 years) from April 1, 2011.

"Several former employees who left their PF savings with us to get tax-free income, are now hounding us to settle their balances," said the finance manager of a firm with over 5,000 workers. These workers are looking to reinvest their savings elsewhere, but the PF trusts are waiting for clarity on the 9.5% interest credit.

"If we settle these accounts without deducting tax and there is no change in the ministry's stance, we won't be in a position to reach these workers and collect the tax," the manager explained.

Even for existing members, taxing 1% of the 9.5% payout is an administrative headache for PF trusts. Usually, the income tax department notifies a tax-free PF rate for the whole year.

However, in 2010-11, the tax-free ceiling is 9.5% from April to August, and 8.5% thereafter. So, trusts that intend to tax PF credits would have to calculate the liability on 1% PF income for seven months.