Calculation of taxable interest on P.F. contribution

The Central Board of Direct Taxes (CBDT) issued a notification on 31 August 2021, stating how the taxable interest will be calculated relating to the contribution to the Provident Fund or Recognised Provident Fund.

Introduction

The earnings from the Provident Fund have remained tax-free for many years. As per the old provisions, a minimum of 12% of salary had to be contributed by employer and employee towards Provident Fund. Excess contribution above 12% of the salary by the employer was taxable. 

To bring the high-income earners excess benefits under the taxability net, the Union Budget 2020 introduced an amendment. Accordingly, employer’s contribution to Provident Fund, National Pension Scheme (NPS) and Superannuation Fund in excess of Rs.7.5 lakh will be taxable as perquisites in the hands of the employee. 

Further, the Union Budget 2021 introduced taxability on the interest accrued on the Employees’ Provident Fund (EPF) account for contributions in excess of Rs.2.5 lakh. The interest accrued on the EPF account will be taxable when the PF contributions exceed Rs.5 lakh in case of government employees (where the employer does not contribute to EPF) in the financial year.

Here also, the government intended to rationalise the tax exemption for the high-income earners by putting a threshold limit.  

To clarify the amendment introduced in the Budget 2021, CBDT issued a notification showing the calculation of taxable interest relating to the contribution to the Provident Fund or Recognised Provident Fund.

As per the notification, this amendment in the income tax rules shall become applicable from 1 April 2022. 

Manner of calculation

The notification stated that for calculating taxable interest of the provident fund contribution, separate accounts shall be maintained for all the financial years starting from the current financial year 2021-22. 

Two different accounts, one with a taxable contribution and another with a non-taxable contribution, shall be maintained for all subscribers. 

Taxable accounts are those for which tax on EPF interest is applicable since the contributions exceed the thresholds limits (EPF contributions exceed Rs 2.5 lakh, and employer's contributions to PF account exceed Rs 7.5 lakh).

Non-taxable PF accounts are those where the EPF contributions are below the taxable threshold limits. Interest on non-taxable PF accounts will continue to remain exempt from tax, like in the old tax regime. 

These two account categories have to be maintained from the financial year 2021-22 onwards.

Calculation of non-taxable contribution

Use below mentioned formula to arrive at the non-taxable Provident Fund contribution :

(A) – Aggregate of the following:

1. Closing balance in the account as of 31 March 2021.
2. Any contribution made by the person in the account for each financial year starting from F.Y. 2021-22 is non-taxable, i.e. below Rs.2.5 lakh or Rs.5 lakh threshold, as the case may be. 
3. Interest accrued on the closing balance as of 31 March 2021, as well as interest accrued on the non-taxable contribution for each financial year starting from F.Y. 2021-22.

(B) – Reduced by withdrawal from such an account. 

Calculation of non-taxable contribution = (A) Less (B)

Calculation of taxable contribution 

Use below mentioned formula to arrive at the taxable Provident Fund contribution :

(A) – Aggregate of the following:

1. Any contribution made by the person in the account for each financial year starting from F.Y. 2021-22 is taxable, i.e. above Rs.2.5 lakh or Rs.5 lakh threshold, as the case may be. 
2. Interest accrued on the taxable contribution for each financial year starting from F.Y. 2021-22.

(B) – Reduced by withdrawal from such an account. 

Calculation of taxable contribution = (A) Less (B)

The threshold limit for non-taxable Provident Fund contribution for employees where the employer does not contribute is Rs.5 lakh (as amended). In all other cases, the threshold limit is Rs.2.5 lakh. 

Let us understand this using an example.

Illustration

Mr A has a P.F. balance of Rs. 5,50,000 (including interest) as on 31 March 2021. He works with a private company and has contributed Rs.3,50,000 (total contribution) into the P.F. account in F.Y. 2021-22. Assuming an interest of 8.5% will be received on the contribution made. 

What will be his taxable as well as a non-taxable contribution for F.Y. 2021-22?

Answer: 

Let us separate the contribution into taxable as well as non-taxable. 

*Assuming deposit is made at the start of the financial year 

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Frequently Asked Questions

Will EPF interest be taxable every year?

Yes, the accumulated EPF interest in the taxable account will be taxed every year. The previous year’s accumulated interest in the EPF account will get carried forward to the following years. Thus, the accumulated interest of last year plus the interest on the contributions made during the financial year will come under the tax ambit.

Is the PF amount taxable upon retirement?

No. The PF amount withdrawn upon retirement is not taxable as the maturity amount is tax-exempt.

Who has to pay EPF tax?

The employees will have to pay tax on the interest accrued in the PF account when their PF contributions exceed Rs 2.5 lakh or Rs.5 lakh in a financial year. Thus, the new rule will impact employees earning over 20,90,000 in a year. Only a few high-income individuals have to check whether EPF is taxable for them.

Is TDS deducted from the EPF interest amount?

Yes. TDS is deducted on such interest under Section 194A of the Income Tax Act. As per the IT Act, the provident fund office or the EPF trust will deduct the TDS. In the case of resident Indians, the 10% TDS rate is applicable if the PF account is linked with Permanent Account Number (PAN). If the PF account is not linked with PAN, TDS will be deducted at a rate of 20%. However, the TDS will be deducted only when the EPF interest exceeds Rs 5,000.

How is EPF interest taxed from employees?

The tax is paid on the interest credited in the taxable EPF account during the year. The interest will be included under the head ‘Income from other sources’. The tax is calculated as per the applicable tax slab rates of the employee. Such employees can claim the tax credit for the TDS deducted from the interest income.

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