By Dheeraj Agrawal, Communication Professional
In a big relief to a large number of middle to high-income earners, the central government has doubled the limit of provident fund contribution on which interest income will remain non-taxable. In the Budget 2021-22, the finance minister Nirmala Sitharaman had proposed to tax interest income on own contribution of employees exceeding Rs 2.5 lakh a year. But in its amendments to the Finance Bill 2021, the government has raised the limit to Rs 5 lakh. This will be applicable for all contributions beginning April 1, 2021.
What does it mean for an individual?
If an individual’s own contribution to the employees’ provident fund in a month is up to Rs 41,666 (Rs 5 lakh in a year), there will be no tax on the interest income. But if the contribution exceeds that, then interest income on additional contribution will be taxed. This means that individuals having a monthly basic salary of over Rs 3,47,216 will now get impacted by the move as their annual EPF contributions (at the rate of 12% of basic salary) would exceed Rs 5 lakh.
What will be the tax amount ?
It will depend on the investment amount, the interest rate announced by the government and your tax slab. But we can give you an example. Suppose, an individual contributes Rs 12 lakh in a year in the EPF, then the tax will be applicable on interest income on Rs 7 lakh (Rs 12 lakh -Rs 5 lakh). If we assume the EPF interest rate of 8.5%, the interest income on Rs 7 lakh would amount to Rs 59,500 and the tax payable on the same would be Rs 18,450 (at marginal tax rate of 30 per cent).
Who will benefit?
The decision to increase the cap on EPF contributions that will have tax-exempt interest income, from 2.5 lakh to 5 lakh per annum, will ensure that individuals earning annual basic salary of up to Rs 41.66 lakh are covered under it. Thus, it will cover almost 99 per cent of the population.
Will it affect the interest income on existing corpus?
The proposal states that the tax will be on the interest income on the contribution exceeding Rs 5 lakh in a previous year. This means that the aggregate corpus (till March 31, 2021) and interest income on that will not get impacted. The tax will be limited on the contribution in excess of Rs 5 lakh beginning April 1, 2021.
What should you do?
While there is a rare chance that any of our readers will be in need to do anything, but if you are the lucky ones (i.e. those having annual basic salary of more than 41.66 lakh), you can stop making investment in EPF more than the cap and look at some other investment options.
Investors who are not comfortable with mutual funds and are willing to pay tax at marginal tax rate on the interest income (on additional contribution), they could still go for high contribution in provident fund. However, those who are comfortable investing in mutual funds can go for debt schemes of proven track records or diversified large-cap funds. While long-term capital gains tax rate (after 12-months) for equity schemes is 10% for gains above Rs 1 lakh, the long-term tax on debt funds is 20% with indexation benefit.
So for tax efficiency purposes and better returns, it is advisable to stop the voluntary contribution to PF if it exceeds Rs 5 lakh in a year, as the interest income will get taxed at a marginal tax rate. Also, since interest rates are on a decline, many experts are of the opinion that going forward, the government may reduce the interest offering on EPF. It means that your corpus may fetch lower return.
