Provident Fund tax differs widely at contribution, on interest earned and on withdrawal. Ask three people on how their PF contribution is taxed and you will get 4 different answers. Without going into the merits and demerits of Provident Fund, let’s understand the taxation involved.
Provident fund has tax implications at 3 stages, at contribution, at the interest earning stage and finally on withdrawal.
Stage 1: Provident Fund Tax on Contributions
Any company and its employees covered under the EPFO mandate by the government of India, deducts a certain amount every month from the payroll of each employee and deposits it with the EPFO Trust.
As you might be aware, there are two parts to provident fund contribution – the employee’s part and the employer’s part.
Taxation under old tax regime
– The employee’s contribution is tax exempt upto a limit of INR 1.5 Lakhs under the Section 80C. Any contribution above INR 1.5 Lakhs is not tax exempt.
– The employer’s contribution is tax exempt upto a limit of INR 7.5 Lakhs, which includes all retiral contributions by the employer. However, this includes EPF, NPS, pension, etc. Any contribution by employer above INR 7.5 Lakhs per year is added as a perquisite and taxed.
Taxation under new tax regime
– The employee’s contribution is NOT tax exempt, as Section 80C does not apply.
– The employer’s contribution is tax exempt upto a limit of INR 7.5 Lakhs. This includes EPF, NPS, pension contributions by employer. Any contribution by the employer above INR 7.5 Lakhs per year is added as a perquisite and taxed. This is similar to the old tax regime.
Stage 2: Provident Fund Tax on Interest earned
As the effects of compounding take effect in the interest earning stage, it is critical to understand taxation on interest earned. Taxation plays a crucial part in the total corpus and returns available at retirement. Unlike the contribution stage, taxation rules are the same for both old and new tax regimes during this stage.
The contributed funds by employee and employer are maintained in two separate accounts for purposes of taxation in this stage. The employee contribution is now further split up. The first INR 2.5 Lakhs of contribution in a given financial year is maintained in a ‘non-taxable account’. And, any further contributions are maintained in a ‘taxable’ account.
Example
For example, let say Mr. Naetik has employee contibution of INR 30,000 every month to PF. The first 8 months account for INR 30,000 * 8 = INR 2,40,000. This is all accumulated in the non taxable account. For 9th month contribution of INR 30,000, the first INR 10,000 is accumulated in the non-taxable account.
At this point, the total contribution has crossed INR 2,50,000. So, the remaining INR 20,000 is added to the taxable account. And the contributions for months 10, 11 and 12 are also added to the taxable account.
Finally, at the end of the financial year, Mr. Naetik has contributed INR 3,60,000 to provident fund. Out of this, INR 2,50,000 is accumulated in the non-taxable account and INR 1,10,000 is accumulated in the taxable account.
When interest is paid on the employee’s contribution, the interest component in the non-taxable account is not taxed. And any interest paid on the taxable account is taxable. Then, the EPFO deducts 10% TDS on the interest . This deduction should be noticeable on your Form 26AS. Then, the employee is responsible to pay advance tax on the interest earned in the taxable account.
The interest earned on the employer’s contribution is not taxable.
Any interest earned on the taxable account in following years is also taxable at slab rate.
No TDS is deducted if taxable interest is less than INR 5000.
Stage 3: Provident Fund Tax on Withdrawal
As on date, withdrawal from EPFO of the accumulated corpus is tax free.