Employee Provident Fund (EPF): What are the new tax rules you need to know?

Employee Provident Fund Organization (EPFO), one of the largest social security organisations in the world, is in charge of managing the welfare programme known as Employee Provident Fund (EPF). Employees should be informed of the tax regulations regarding investments, accruals, and EPF withdrawals.

Based on an interview with Preeti Sharma, Partner/Global Employer Services, Tax & Regulatory Services – BDO India, the spokesperson said “Employee Provident Fund (EPF) is India’s most popular retirement financial planning and investment choice for individual taxpayers. EPF was earlier under the Exempt taxation framework, i.e., EPF was tax-free at:

Investment stage: When a contribution was made, one could claim a deduction under section 80C against the employee’s contribution upto INR 1.5 lakhs and the entire employer’s contribution upto 12% of PF salary was exempt without any ceiling

Accrual stage: When interest is declared on the accumulated balance

Maturity stage: When the amount is withdrawn from the fund subject to meeting exemption criteria

The Indian Government in order to promote the National Pension Scheme and tax High Net-worth Individuals has done away with a few of the above tax benefits by making the following changes according to Preeti Sharma.

Tax rule on EPF contributions

Employee’s contribution to the EPF account is allowed as a deduction under Section 80C but within the overall limit of INR 1.5 lakhs. There is no change in this provision.

Employer’s contribution to the EPF account of an employee is exempt upto 12% of the PF Salary. Effective 1 April 2020, any employer’s contribution to Provident Fund (PF), NPS and superannuation exceeding INR 7.5 lakhs per year is taxable as perquisites in the hands of the employee under the head ‘Income from Salary’.

EPF tax rule on accrual of interest

Effective 1 April 2022, any interest on an employee’s contribution to EPF upto INR 2.5 lakhs per year is tax-free and any interest earned on a contribution over and above INR 2.5 lakhs is taxable in the hands of the employees. The threshold of INR 2.5 lakhs is increased to INR 5 lakhs in case the employer is not contributing towards EPF.

As per the notification issued by the Income Tax department dated 31 August 2021, the Regional Provident Fund Commissioner (RPFC) will maintain the EPF balance of individuals in two separate accounts for taxation purposes. The contribution within the limit of INR 2.5lakhs/5lakhs in one account and the excess contribution along with the interest accrued on it shall be maintained in a separate taxable account. The RPFC shall deduct TDS on such interest paid on the account maintaining taxable contribution.

Further, in addition to the contribution made by the employer in excess of INR 7.5lakhs per year that is taxable as perquisites in the hands of employees, any interest, dividends, etc. earned from such excess contribution will be taxed as well in the hands of the employee.

Rule 3B has been introduced by the Income Tax department to ascertain how interest, dividend, etc. will be calculated on the above contribution. Employers also need to withhold tax on such accruals.

Further, employers also need to provide the details of such accruals and taxes withheld in Form 16 and Form 12BA issued to employees.

Tax rule on withdrawals of EPF

No tax is required to be paid on the contribution amount and accumulated interest in case the accumulated balance in EPF is withdrawn after 5 years of continuous service.

However, in case the accumulated balance is withdrawn prior to the completion of 5 years of continuous service (allowed by the RPFC in case of prescribed circumstances), then the balance and interest won’t be fully exempted from tax. The tax on such withdrawal shall be calculated as follows:

a) Employer’s Contribution and Corresponding Interest

Employer’s contribution and interest on the same is fully taxable in the hands of the employee under the head ‘Income from salary’ in the individual’s Income Tax return.

b) Employee’s Contribution

In cases where deduction under Section 80C is claimed at the time of contributing, the amount of the employee’s contribution shall become taxable as ‘Income from Salary’. In other cases, the amount withdrawn from an employee’s contribution may not be taxable.

c) Interest on Employee’s Contribution

The amount of interest earned on the employee’s contribution to EPF shall be taxable in the hands of the employee as ‘Income from Other Sources’.

The RPFC shall deduct TDS at 10% on the total amount withdrawn (if more than INR 50,000) before the completion of 5 years of continuous service.

Impact and budget expectations

Despite the above changes, EPF still remains the most loved and sought-after retirement planning scheme for the majority of individual taxpayers. The above changes may not affect individuals who are earning a basic salary upto INR 20 lakhs and contributing 12% of their basic salary towards EPF. Most individuals in India fall under this category.

While it is expected that the above provisions on EPF taxation may not change in the 2023 Union Budget, there is an expectation that the limit of deduction available under Section 80C may be increased from the current limit of INR 1.5 lakhs, said Preeti Sharma. 

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