Comment

Establishments that have recognised provident funds (PF) may lose their status if they fail to obtain an exemption on or before December 31, 2010 from applicability of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, (the PF Act).

At present, these establishments which had provident funds set up before March 2006 enjoy recognition under the provisions of the Income Tax Act, 1961, (the Act).

The Finance Act, 2006, introduced the requirement to obtain exemption from the PF Act to provide legislative synergy between the Act and the PF Act.

Initially, the companies were asked to obtain the exemption by March 31, 2007. However, they were given an extension more than once to provide adequate time to the Employees’ Provident Funds Organisation to decide on the applications for exemption.

The last extension was given up to December 31, 2010 (on earlier occasions extensions were granted till the end of the financial year). As of now, this deadline has not been extended.

This deadline could pose a problem for employers whose applications are still under consideration for exemption by the PF authorities and for employers who have not applied for PF exemption at all (but covered by the PF Act).

As per the provisions of the Act, the recognition to PF will be withdrawn if exemption from the PF Act is not obtained by December 31, 2010.

However, the failure to obtain an exemption may not result in automatic withdrawal of recognition to PF as any such withdrawal could be by way of an order passed by the tax authorities (i.e. Chief Commissioner or Commissioner) and that too after providing a reasonable opportunity to the employer and trustees of the provident fund.

If the PF gets de-recognised on account of failure to obtain exemption under the PF Act, then it could expose the employers, employees and the trustees to the PF to adverse tax consequences.

In case of employers, the deduction would not be available for the contributions made to PF.

Employees would not enjoy exemption towards the employer’s contributions and would not be entitled for deduction for their own contributions made to the PF.

Also, the trustees would be liable (as representative assessees) to tax in respect of the income of the provident fund. Further complications can arise as there is a lack of clarity on whether the de-recognition would be effective on prospective basis or on retrospective basis.

As per the provisions of the Act, the order withdrawing recognition is to take effect from the date from which it is made by the tax authorities.

However, one of the rules prescribed by the Central Board of Direct Taxes (CBDT) requires that the accumulated balance to the credit of each employee at the end of the financial year prior to the date of such withdrawal of recognition¬ shall be paid to him free of tax and the remainder of the accumulated balance due to him shall be liable to tax as if the fund had never been recognised.

The CBDT-prescribed rule goes to suggest that de-recognition is effective retrospectively as far as the taxability of the sums received by the employees are concerned.

It is an untested position of law whether such a rule prescribed by the CBDT is ultra vires in so far as it seeks to expand the scope of taxation by providing for retrospective effect of de-recognition in contrast to what is provided under the rules forming part of the statute.

Further, in case of resigned/retired employees who are already paid tax free amounts, a question would arise on how the retrospective effect of de-recognition would apply or take effect and a related question would also be whether the employer is under an obligation to deduct tax from the amounts so paid/payable to employees or is it the liability of employees to pay tax.

In an extreme case, even the trustees of PF may be made liable (as representative assessees) to tax on retrospective basis with respect to the income of the provident fund.

Also, it will be an area of concern for employees on whether they will be entitled for deduction under Section 80C of the Act for the contributions made by them during the financial year in which de-recognition of the provident fund takes place.

Thus, the CBDT-prescribed rule needs to be suitably amended to provide for scope of taxation in line with the provisions of the Act.

The need of the hour is also to extend the statutory time limit with effect from January 1, 2011 for the PF authorities so that employers whose applications for exemption were pending as on December 31, 2010 are not put to a disadvantage.

As of now, the employers are left with limited options i.e. either follow up with the PF authorities on a consistent basis or consider the option to transfer the funds to the Provident Fund account maintained under the PF Act.

This uncertain scenario calls for an immediate extension of the statutory time limit which is possible only by way of an Ordinance being passed by the President of India to this effect else it may find its place in the forthcoming budget.

Rajesh Bhagat is a senior manager and Jitendra Trivedi is an associate, PricewaterhouseCoopers. Views are personal