How new Provident Fund interest rules impact your pocket

Interest now earned from contributions above thresholds will be treated the same way as interest earned by term deposits in banks

Hyderabad: Finance Ministry recently notified rules for taxing interest on Employees Provident Fund (EPF)’s contributions that are higher than the thresholds limit. The thresholds are set at Rs 2.5 lakh where there is an employer contribution and at Rs 5 lakh where there is no employer contribution.

Previously, the entire interest on contributions to the PF was exempted from tax. As a result, several high net worth individuals parked surplus amounts in PF to earn a decent, tax-free return. However, this February, the Budget had proposed to tax the interest on PF contributions above thresholds. The interest now earned from contributions above the thresholds will be treated the same way as interest earned by term deposits in banks.

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Two accounts

“Employees can now expect to receive an EPF statement which demarcates taxable and non-taxable portions. Earlier, the statement included opening balances, month-wise employee/ employer contributions, yearly interest credited. The system will now have to separately calculate interest for taxable and non-taxable portions of the balances. However, it is not specified how withdrawals will be allowed – whether employees will have a preference to withdraw from either of the contribution accounts,” said Archit Gupta, Founder and CEO of Clear.

Impact

The Central Board of Direct Taxes (CBDT) has inserted Rule 9D, according to which income through interest (above the interest for Rs 2.5 lakh and Rs 5 lakh limits) will be put in taxable contribution account. The closing balance on March 31, 2021 and the interest on it will be treated as the non-taxable component.

Assuming a person is in 30 per cent tax bracket and contributes Rs 3 lakh every year to the Provident Fund. In this case, the interest earned on Rs 2.5 lakh is not taxed. However, interest on the additional Rs 50,000 will be taxed. Assuming 8 per cent interest is offered, the additional Rs 50,000 contribution will fetch an interest of Rs 4,000. This Rs 4,000 earned will be taxed at 30 per cent as per the person’s income tax slab and the tax liability here will be Rs 1,200.

Suppose if the person contributes Rs 12 lakh in a year, tax will be applicable on interest coming on Rs 9.5 lakh after excluding the Rs 2.5 lakh limit. In this case, the interest earned on the additional the contribution will be Rs 76,000 and the tax liability would be about Rs 22,800 as per the 30 per cent income tax slab, the tax assessee is in.

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