Celebrations cut short, extra 1% EPF interest to be taxed

NEW DELHI: The government’s surprise gift for workers isn’t much of a gift after all. The labour ministry has hiked the employees’ provident fund, or EPF, rate to 9.5%, but a finance ministry notification says that anything in excess of 8.5% will be taxed.

The labour ministry is, however, confident that the tax department will renotify the higher rate, as otherwise a lot of contentious issues will come up. Labour Minister Mallikarjun Kharge had declared a 9.5% bonanza on provident fund deposits on September 15 — marking a one percentage point increase in the rate from the 8.5% paid in the last five years.

But even before the EPF board met under Kharge, the Central Board of Direct Taxes had notified a tax-free PF rate of 8.5% for 2010-11 — effective from September 1. This means that the 1% extra income (or Rs 1,700 crore) that the labour ministry has projected as a gift to the workforce, would be fully taxable. This is the first time ever that income from provident fund would be taxable, if the tax department does not notify the higher rate.

Historically, the tax-free PF rate notified by the income tax department has never been lower than the EPF rate declared for the year.

In recent years, while the EPF rate was at 8.50%, the ceiling was at 9.50%. This year, when the EPF rate has been hiked to 9.50%, the ceiling on tax free provident fund returns has been lowered to 8.50%. “The incremental PF return would be taxable in the hands of the worker. This has never happened before,” said Bhupendra Meel, associate vice president in charge of retirement trust solutions at AK Capital Services.

But levying the tax would be far from easy. The PF interest would be credited to workers’ accounts at the end of the year. The trust in charge of the PF would be responsible for deducting the applicable tax at that time.

Usually, the income tax department notifies a tax-free PF rate for the whole year. But this year, it’s only applicable from September 1. So the 9.5% provident fund return would be tax-free from April to August, but taxable thereafter. “For company-run trusts, this would be a headache — calculating the tax liability on 1% PF income for seven months,” said Amit Gopal, senior vice president at India Life Capital.

But the most acute problem will be faced by the Employees’ Provident Fund Organisation – which manages 5 crore PF accounts.

Firstly, EPFO simply doesn’t have the systems in place to deduct tax at source. All PF account withdrawals before completing five years of service, are fully taxable, as per existing income tax rules. But the rule has never been implemented because of EPFO’s unreliable manual record-keeping systems.

Even if EPFO could deduct tax at source before crediting interest to members, the applicable income tax bracket would vary for its members. For every deduction made, it would also have to give workers a Form 16 statement.

For an organization that doesn’t even give members annual account slips on time, mailing 5 crore ‘Form 16’ sheets would be physically impossible. Experts reckon the PF office could instead put the onus of paying the tax on employees filing their returns.
EPFO board members, however, are confident that the Income tax department would reconsider its decision. “As per procedure, the EPF board recommends the PF rate to the finance ministry. I think the revenue authorities may have to re-notify the tax-free ceiling,” said AD Nagpal, secretary of the Hind Mazdoor Sabha.

The finance ministry would have to take a call on dealing with the contentious issues thrown up by this unprecedented situation. It could decide to accept the 9.5% EPF rate and drop the 8.5% rate notified by it. Alternatively, it could stick to its own notification and ask the EPFO to levy tax on the 1% incremental return. 

Source - The Economic Times