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Consider tax impact on your PF money while quitting job
June, 04th 2007

Are you starting a new job or giving up your job to start a business? As you evaluate your options, you may want to consider the tax impact on your Recognised Provident Fund. The employers contribution to a Recognised Provident Fund (RPF) is exempt from personal tax up to 12% of salary (salary for this purpose means basic salary and includes dearness allowance and dearness pay if the terms of the employment so provide).

The employees contribution to RPF forms part of salary and qualifies for deduction under section 80C of the Income-Tax Act, 1961, subject to a limit of Rs 1,00,000 along with other specified investments. Interest credited to RPF is also exempt from tax if it does not exceed the notified rate.

A lump sum payment received from the RPF at the time of retirement or termination of employment is not considered as taxable if the employee has rendered services for a continuous period of five years or more or if the employment is terminated because of his ill health or discontinuance of employers business or because of causes beyond his control.

The lump sum payment will also be exempt from tax if the balance due to the employee, instead of being paid to him upon cessation of employment, is transferred to the RPF account with the new employer and withdrawn after a total period (straddling both employments) of five years or more.

To take an example, Mr M who was working for X Ltd for two years (which was his first job) withdrew the balance in the RPF to set up his own business. In such case, the balance received from the RPF account equivalent to employers contribution, interest on employers contribution and interest on employees contribution will be considered as Mr Ms taxable income.

The part of the accumulated fund representing employer contribution and interest thereon is taxable as salary and the interest on the employee contributions will be taxed as income from other sources. Mr Ms own contribution will also become taxable if he had taken a deduction from income under section 80C of the Act.

Now, what if Mr M had taken up another job with Y Ltd for the next four years and transfers the balance in the RPF account maintained with X Ltd. to the RPF account with Y Ltd. In this case, when Mr M withdraws the money from RPF then as the withdrawal takes place after six years, the amount withdrawn is completely non-taxable as of now.

Although this might change, with the government looking to bring in the Exempt Exempt Tax (EET) system of taxation wherein such amounts in the RPF account when withdrawn will be taxable, however, the EET system of taxation is still a proposal.

An interesting perspective on taxability of accumulated funds in the RPF is put forth by the Delhi Income Tax Appellate Tribunal in its decision in case of ONGC Ltd. Vs ITO (2005 4 SOT 333), wherein the Tribunal has held that interest earned and credited to the RPF account of an ex-employee after termination of his employment will be taxable.

The Tribunal ruled that the interest income will be taxed under the head income from other sources and not as salary as the employee is no longer in employment even though he continues to maintain his account within the RPF account of his ex employer.

To explain the Tribunal ruling further, if Mr M sets up his business after four years of employment with Y Ltd and continues to maintain the RPF account with Y Ltd, then such interest income will be liable to personal tax in the hands of Mr M as Income from other sources as the Act only exempts the balance which is due to an employee on the day he ceases to be in employment of the company.

Thus, Y Ltd must withhold tax under Section 194A of the Act on the interest credited to Mr M. Thus, even if maintaining a RPF account with your ex-employer may give you a good rate of return, it should be kept in mind that this earning is not tax free. Similarly, there is scope for tax saving on your substantial RPF balances depending on how and when you withdraw.

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