While delivering her Budget 2021 speech, Finance Minister Nirmala Sitharaman announced some changes to the existing PF tax rules. While there are lots of confusions regarding these changes, one thing is for sure: if you fall in the high-income group, you may feel a bit of ‘pinch’, after 1 April 2021.

In this article, we will tell you everything you need to know about these changes and how these new provisions will impact you.

Here we go!

The announcement

The Finance Minister announced that any interest earned on EPF contributions over Rs 2.5 lakh per annum will be taxed. This new rule will come into effect from 1 April 2021 for all PF contributions, statutory or voluntary. Both the houses of parliament have already passed the Finance Bill, and hence there is no chance of a rollback of this provision.  Please note that this new provision talks only about the employees’ contribution to the fund and not the total contribution (employee + employer) during a given year.

The FM announced that any interest earned on EPF contributions over Rs 2.5 lakh per annum will be taxed. This new rule will come into effect from 1 April 2021 for all PF contributions, statutory or voluntary.

The impact

As per the EPF rules, at least 12% of the basic salary and performance wages of an employee is compulsorily deducted from the provident fund every month. Till now, all such contributions up to Rs 1.5 lakhs enjoyed tax exemptions under section 80C. The withdrawals and the interest accrued were tax-free. Now, with the new EPF taxation rule, the government looks to keep the high-income earners away from availing the tax benefits.

The Finance Minister announced during her Budget speech that this new rule would impact less than 1% of the contributors. From 1 April 2021, the changed income tax rules will be applicable to the PF accounts of the employees. The interest accrued on PF/EPF contribution over Rs 2.5 lakhs will become taxable. The income tax rate will be decided based on the tax slab of an individual taxpayer, after the addition of the PF/EPF interest earned (if any), during the year.  Therefore, you need to check your monthly contributions to the PF/EPF account and see if they are in excess of the annual limit of Rs 2.5 lakh.

Here is an example to make it clear

Let us give you an example so that you can comprehend the new PF rules better. Let us assume you are contributing Rs 25,000 per month (Rs 3,00,000 per year) to your PF account for the Financial Year 2021-22. The government has already declared the PF interest rate at @8% for FY 2021-22.  At this rate, you will be earning an interest of Rs 24,000 on your PF contribution in this financial year.

Now, the new PF rules say that the interest accrued on contributions up to Rs 25,000 will not be taxed. Therefore, there will be no tax on the interest amount up to Rs 20,000. However, you will need to pay tax on the additional interest accrued. In your case, the additional amount of Rs 4000 will be added to your applicable income tax slab and you will be taxed accordingly.

Here are the calculations you are looking for:

Your annual contribution towards the PF account – Rs 3,00,000

Interest accrued on this contribution of Rs 3 Lakhs (@ 8% PF interest) – Rs 3,00,000 * 0.08 = Rs 24,000

Tax exempted on the interest accrued on the PF contribution – Rs 2,50,000 * 0.08   = Rs 20,000

Tax applicable on PF interest accrued (Over and above Rs 2.50 lakhs) – Rs 24,000 – Rs 20,000 = Rs 4,000

As per the prevailing interest rate, let us assume you fall in the 10% tax slab. Therefore, a TDS of 10% will be deducted from the taxable interest amount of Rs 4000.

Impact on the VPF contributors

In addition to the high-income earners, another section of the salaried employees will be impacted by this new rule. Many salaried employees contribute more than the mandatory 12% of their salaries to the Provident Fund and look at it as a profitable investment option. They use the VPF (Voluntary Provident Fund) for this purpose. The VPF provides an appreciable tax-free return on EPF balance, with a sovereign guarantee. This group of people will now be discouraged from putting more money into the VPF as they will no longer obtain the tax benefits on contributions over Rs 2.5 lakhs. If you are one of them, you should reassess and have a fresh look at VPF as an investment option. You may decide to lower your VPF contribution, in order to stay exempted from tax.

Are there any other options?

Because of this new provision of taxing the PF interest income, some employees may consider exploring other options. Experts are of the opinion that those contributing up to Rs 20,835 per month (as the employee contribution) to the EPF are not going to be impacted. They may continue with the contributions as before. The others may explore market-linked investments to park their money. They may start with less volatile debt and equity funds. 

Also read

Don’t miss these tax and compliance deadlines in March

Employees Provident Fund: What it means & how employers can register for EPF

Everything an employer needs to know: PF, ESI, Bonus & Gratuity

Why is it mandatory for an employer to contribute to EPF?

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