How will EPF corpus withdrawal be taxed?

Live Mint

Deepti Bhaskaran

To bring parity between the Employees’ Provident Fund (EPF) and the National Pension System (NPS), the Finance Bill 2016 made EPF partially taxable on withdrawal and NPS partially tax-free on withdrawal. Further, the budget also made the employer’s contribution taxable in your hands if it exceeds `1.5 lakh in a year. For about 37 million subscribers of Employees’ Provident Fund Organisation (EPFO), the decision is a painful one but there is some good news: the new rules apply to contributions that are made from financial year (FY) 2017 onwards and it doesn’t apply to you if you earn `15,000 or less a month.

However, how the new rules will play out and what part of your EPF corpus will be taxed still remains to be seen as further clarity is awaited. But so far, what we know is: you will be taxed on the interest component of 60% of the contributions (http://mintne.ws/1RhOnMs).

Earlier, it was communicated that the entire 60% of withdrawn corpus will be taxable—principal plus interest—causing an uproar among salaried Indians.

Here is an explanation of how this could work, and we will tell you more as the rules become clear. Start with understanding the two products first.

What are EPF and NPS?

Every month, a salaried individual contributes 12% of her salary to the EPF account and the employer matches the contribution. A part of the employer’s contribution goes to the Employees’ Pension Scheme. The contributions made to EPF then compound at a rate declared by the EPFO every year. Currently, the rate is 8.8% per annum. Employee contribution up to `1.5 lakh qualifies for a tax deduction under section 80C of the Income-tax Act, 1961. If you withdraw the corpus after five or more years of continuous service or on retirement at 58 years of age, the corpus is tax-free. “EPF rules allow you to withdraw money on events like unemployment for two months or if women resign on grounds of marriage or childbirth. But the new rules, which are applicable now, state that in such cases, the employee can withdraw only her contributions and the interest paid on it. The employer’s contribution will continue to be in your account and will be made available to you only on retirement at 58 years,” said Amit Gopal, senior vice-president, India Life Capital Pvt. Ltd.

Even as EPF is a voluntary scheme for those with a salary of more than `15,000 per month, most employers include all their employees in the EPF scheme. On the other hand, NPS is purely voluntary. You can subscribe to it on your own, or through your employer under the corporate NPS scheme. You need to invest in NPS every year and on retirement, at age 60, you can keep up to 60% of the corpus (which till now was taxable in your hands) and the remaining 40% needs to be annuitised. Annuity is a pension product that gives you periodic income.

On the annuitised 40%, you don’t pay a tax but the annuity income is taxable in your hands. As per section 80CCD, 10% of your salary (gross income if you are non-salaried) that is contributed to NPS, is eligible for tax deduction up to `1.5 lakh, and an extra deduction of `50,000 under Section 80CCD (1b).

In a corporate scheme, there is an added deduction. “If the employer’s contribution exceeds 10% of the salary, then you get a deduction of only up to 10% and the remaining gets added to the income of the employee, which is taxable,” said Sonu Iyer, national leader, people advisory services, EY.

Watch: Tax on Provident Fund: Fact vs fiction

Video player from: NDTV (Privacy Policy)

Possible tax rules

Tax on interest: The new rules that will apply from FY17 will tax only the interest component in the EPF. This means that when you make a withdrawal from your EPF account, the interest accrued on 60% of the contributions made from FY17 onwards will be taxable and interest accrued on the rest 40% will remain tax free. Say, you withdraw from EPF on retirement. You had contributed `1,000 over the years and on this, you earned an interest of `80. This means you would pay a tax on 60% of `80, or on `48, and the remaining `32 can be had tax free.

Mint Money did the numbers and the actual tax to be paid on the accumulated corpus is 1.4% for a person in the highest tax bracket of 30.9% (see graphic for calculation). On contributions alone, the tax incidence is 6.6% at the highest tax bracket. But if the tax applies only on the interest component of employee contributions, the tax incidence will be lower.

“We are awaiting clarity on this because the intent of the budget speech was to exempt up to 40% of the total corpus on withdrawal. The Finance Bill suggested that employer’s contribution and interest will continue to be non-taxable and 60% of the employee’s contributions and interest will be taxable,” said Iyer. “The revenue secretary clarified that it will be 60% of the total interest component of contributions from employer as well as employee that would be taxed. A press release from PIB (Press Information Bureau) suggested that it’s back to what the finance minister said: that 40% of the total corpus is exempt and the remaining 60% is taxable unless invested in annuity plans. The release notes that the finance minister will reconsider and clarify what the real position is going to be,” she added.

However, if 60% of the entire withdrawn amount is taxed, then the incidence would be about 18.54% for someone in the highest tax bracket of 30.9%.

The new rules are being written to nudge you to annuitise your money. You can escape the tax if you annuitise 60% of the corpus and take 40% lump sum tax-free. According to the press release issued by the Ministry of Finance, there are about 6 million contributing members who have accepted EPF voluntarily and are highly-paid private sector employees. “Such an employee can withdraw without tax liability provided he contributes 60% in an annuity product so that pension security can be created for him according to his earning level. However, if he chooses not to put any amount in annuity product, the tax would not be charged on 40%,” added the release. The tax, however, would be on the interest component, as it appears from the clarification for now.

Cap on employer contribution

What may hurt is if the contribution of your employer exceeds `1.5 lakh. As of now, you don’t pay tax on your employer’s contribution. But from the next FY, if the employer’s contribution is more than `1.5 lakh a year, then the differential amount will be added to your salary and taxed. “So, if the employer is contributing on a salary of `12.5 lakh per annum, 12% contributions will work out to be `1.5 lakh per annum. So, if the employee’s salary is `18 lakh a year, the employer’s contribution will be `2.16 lakh. This means `66,000 will get added to the employee’s salary as income and taxed,” said Kuldip Kumar, partner and leader-personal tax, PwC India.

Will the employer cap its contributions to `1.5 lakh? “EPF laws do give a window to employers and employees to restrict contributions up to a salary of `15,000 per month. But again, employers can’t unilaterally reduce it. It would be good to get a clarification,” added Iyer.

© LiveMint Mint

What about NPS?

For NPS, on retirement, 40% is annuitised and 60% is available as lump sum. The annuity income is taxed. The 60% amount is fully taxable. The PIB release states that 40% of the total corpus withdrawn at retirement will be tax exempt both under recognised provident funds and NPS. Say, you accumulate a corpus of `1,000 at 60 years of age. You have to annuitise `400; you can take the remaining `600 as lump sum. The way experts interpret the new rules, is by calculating 40% on `1,000 (which is `400). So, of the `600 that can be withdrawn as lump sum, `400 is tax-free and `200 is taxable. But if you annuitise the entire corpus, you don’t pay tax (annuity is taxed).

How does annuity help?

Annuity gives you pension for life. “Annuity markets are currently underdeveloped and it wouldn’t make sense to lock in 60% of corpus in annuities. Markets may develop but you should also factor in the fact that people may want liquidity. If only the interest component is taxed, the tax incidence is not much. It’s better to have the freedom to use the money as you want than to annuitise it,” said Suresh Sadagopan, a Mumbai-based financial planner.

What should you do?

The intention is to nudge you towards NPS. To do this, the Budget also announced an exemption for a one-time portability from a recognised provident fund or superannuation fund to NPS. So, should you go ahead? Our advice is: no. Wait and watch for now.