EPF taxation: After darkness, comes the light

The finance ministry took a step back on Tuesday on its Budget announcement on taxing withdrawal of employee provident fund (EPF).

A day after Finance Minister Arun Jaitley said that 40% of the total EPF corpus would be exempt from tax and 60% would be taxed, revenue secretary Hasmukh Adhia clarified that the ministry was not talking about the entire 60% corpus but only its interest component. That too, contribution to the corpus from April 1, 2016, and not the accumulated corpus.

By Tuesday afternoon came another clarification from the ministry that reiterated what the finance minister had said in his Budget speech but added that an employee could avoid tax on full EPF corpus if it was invested in an annuity plan.

Sonu Iyer, tax partner & national leader - people advisory services, EY India, said that there was a strong chance that the proposal to amend the EPF rule may be "completely rolled back."

"I think there is a very strong chance of this thing being completely rolled back," she said.

The rule, the ministry statement said, applies to only "about 60 lakh contributing members who have accepted EPF voluntarily and (they) are highly paid employees of private sector companies".

The ministry also clarified that inherited annuity would not be taxed and an Employees' Provident Fund Organisation (EPFO) member with a salary of less than Rs15,000 per month and Public Provident Fund (PPF) will not be affected.

The main category of people for whom EPF was created are members within the statutory wage limit of Rs15,000 per month, it said. Out of around 3.7 crore contributing members as on today, around 3 crore subscribers are in this category.

Which means, the new move would affect only 60 lakh of the 3.7 crore members.

"This category can, at present, withdraw money without any tax liability. We are changing this. What we are saying is that such an employee can withdraw without tax liability, provided he contributes 60% in annuity products, so that pension security can be created for him, according to his earning level," it said.

"However, if he chooses not to put any amount in an annuity product, tax would not be charged on 40%," said the statement. Forty per cent of EPF contribution is not taxed anyway.

Finance minister Arun Jaitley has stirred a hornet's nest on Monday by including a proposal in his Budget to tax the withdrawal of 60% amount of an employee's contribution to EPF.

Currently, EPF is exempt from taxes and can be fully withdrawn after 60 days of an employee's exit from a firm.

Under the new norm, the government proposes to restrict withdrawal to an amount not exceeding the employee's contribution and interest accrued on it on cessation of employment.

The full amount can be pulled out only after the retirement age – 58 years (moved up from the current 55) – and would be taxed if not invested in an annuity scheme.

This has led to widespread outrage among the salaried class, who have joined forces to protest against it.

The outcry against the new norms is so strong that it has put the government on the back foot and forced it to come out with a clarification in less than 24 hours of its announcement.

An 11-point clarification note by the finance ministry said: "The purpose of this reform of making the change in the tax regime is to encourage more number of private sector employees to go for pension security after retirement, instead of withdrawing the entire money from the PF account".

It made it clear that 40% or the interest component of the EPF kitty would not be taxed and the remaining 60% would be exempted if put in an annuity.

"So, what it means is that the entire corpus will be tax-free, if invested in annuity," said the finance ministry statement.

Claiming that the finance minister was studying representations from "various sections", the ministry said it would take "a view on it in due course".

Amit Maheshwari with chartered accountancy firm Ashok Maheshwary & Associate said: "The government clarification makes its EPF reforms look better, but there is no denying it has done a U-turn.

"Comparatively, EPF rules look better after they (the government) have clarified. Basically, they have done a U-turn. They have developed cold feet because people are criticising them," he said.

Iyer of EY India said: "From a point of view of taxation of income, if at all there is a case for taxation, it would be for taxing interest income and employer's contributions up to Rs1.5 lakh because the rest of the corpus is built up from tax paid income".

According to her there was only one annuity in the market; "To my knowledge, there is a provision 68 NNN in the Provident Act, which says if you want to purchase an annuity from the money that you are getting from your PF, you have to write to the PF Commissioner and then he will allow you to buy annuity plan from the Life Insurance Corporation of India (LIC)".