The government has decided not to raise the investment limit on the tax deduction allowed for contributions to the public provident fund (PPF) beyond Rs 70,000 a year. A final decision has been taken on the issue after several representations were received by the Central Board of Direct Taxes (CBDT) seeking an enhancement of this ceiling to Rs 1 lakh.

This means individuals making contributions to their public provident fund (PPF) accounts during FY07 will be able to claim a tax deduction of only up to Rs 70,000.

Right now, an individual can claim a tax deduction of up to Rs 1 lakh for contributions made to certain savings instruments, including life insurance premia, provident fund or schemes for deferred annuities, purchase of infrastructure bonds, payment of tution fees and repayment of the principal amount on housing loans.

An investor has the flexibility to contribute up to Rs 1 lakh in a single instrument or in a slew of them. The only exception is PPF, where an investor can claim a tax deduction on contributions of up to Rs 70,000 only.

According to a senior official, the CBDT received representations, seeking an enhancement of the cap. But the government has decided not to raise the investment ceiling as it reckons that PPF is a relatively high-cost borrowing.

It guarantees a yearly 8% return to investors with the investment being completely risk-free. The scheme runs for 15 years with a provision for a roll-over of five years, though withdrawals are allowed after the sixth year.

Besides, a PPF account holder is also exempt from paying tax at all three stages contribution, accumulation and at the last stage withdrawal. In technical parlance, this is known as the EEE method of taxation, where contributions to specified savings schemes, accumulations (earnings on investments) and withdrawals are exempt from tax.

PPF collections grew at a scorching pace in the late nineties. However, over the last few years, this instrument has lost sheen, with retail investors looking at stock and mutual fund investments. In FY06, for instance, PPF collections grew by a modest 5.5% to top Rs 12,330 crore.

Prior to FY06, individuals were allowed a tax rebate on contributions made to the savings schemes under Section 88 of the Income Tax Act. There were sectoral caps as well. For instance, a tax deduction of up to Rs 30,000 was allowed on purchase of infrastructure bonds.

The system of tax rebate was scrapped in the 05-06 Budget since it was perceived to be distortionary. Instead, individuals were allowed a tax deduction of up to Rs 1 lakh under Section 80C.

Sectoral caps were also removed to give flexibility to the assessee to invest in one or more of the instruments within the overall ceiling of Rs 1 lakh. However, PPF was the only instrument where the investment cap of Rs 70,000 still holds.

The government has also signalled its intention to move to the exempt-exempt-tax method (EET) for taxing savings instruments. Under this method, contributions and accumulations will continue to be exempt from tax.

But withdrawals or benefits would be taxed. In other words, some of the instruments, including PPF, could lose their tax-free on maturity status down the line.