How taxing interest portion of EPF impacts you

Budgets are expected to bring about volatility in the stock markets. But, not many Budget announcements would have created a stir in a debt based product called employee provident fund (EPF).

Budget 2016 proposes to do away with the exempt-exempt-exempt (EEE) status of EPF and therefore tax it on maturity. This according to FM is being done to remove the distortions in the pension schemes by removing any anomalies between them.

But, the picture isn't clear yet. What's going to be taxable is still lacking clarity? Will the employee's contributions or employer's contribution or both will be taxed or will it only be the interest accumulated on employee's portion? Government is expected to come out with FAQ's on the same

Here's how the confusion arose:

In the Budget speech the FM said - In case of superannuation funds and recognized provident funds, including EPF, the same norm (referred to NPS) of 40% of corpus to be tax free will apply in respect of corpus created out of contributions made after 1.4.2016.

Minister of state for finance Jayant Sinha tweeted - We have noted concerns about changes in tax treatment for EPF/PPF/NPS. Full clarification with FAQs will be issued shortly.

Yesterday, Revenue Secretary Hasmukh Adhia clarified, "The principal amount will not be taxed and will continue to remain tax exempt on withdrawal. What we have said is 40 per cent of the interest accrued on contributions made after April 1 will be tax exempt and its remaining 60 per cent will be taxed." He added: This 60 per cent will also be tax exempt if it is invested in a pension annuity schemes.

Sonu Iyer, Tax Partner & National Leader - People Advisory Services, EY says, "Amidst all this confusion, the silver lining is that as per the PIB release, Finance Minister will consider the various suggestions received on this matter and will take a view in due course. From a point of view of taxation of income, if at all there is a case for taxation then it would be for taxing interest income and employer's contributions up to Rs. 1,50,000 because the rest of the corpus is built up from tax paid income!" ..

Let's run some numbers to see how the tax hit is:

Assuming basic salary of Rs 3 lakh (Rs 25,000 monthly), the employee contribution of 12 percent is Rs 3,000 while employer's contribution of 3.67 per cent is Rs 917.5 making a total monthly contribution towards EPF equal to Rs 3,918 (rounded off) for the employee.

Let's say the employee has 20 years to retire and there are no increments. Assuming interest rate of 9 per cent per annum, the total corpus becomes Rs 25,00,000 ( including contributions and interest)

Here's the break-up:
Total corpus Rs 25, 00,000
Contributions made Rs 9, 40,000
Interest earned: Rs 15, 60,000

Note: The interest rate in EPF is calculated on monthly reducing balances.

Now, as per the Budget 2016 proposals and clarifications thereafter, here's the tax hit:

Contributions of Rs 9, 40,000 remain tax-exempt.
40 per cent of total interest earned i.e Rs 15,60,000 comes to Rs 6,25,000 which will be tax-exempt.
The balance 60 per cent of the total interest earned i.e Rs 15,60,000 comes to Rs 9,37,000 which will be taxable.

At 30.9 per cent, the individual pays a tax of Rs 2.9 lakh in the year of retirement, which is nearly 18 percent of the total interest earned.

If the 60 per cent amount is put into an immediate annuity scheme, there's no immediate tax liability but the annuity received will be taxable as and when received over lifetime.

Conclusion
On retirement, one receives retirement benefit from one's employer. The tax liability therefore could be huge. On top of it, if taxation of 60 percent of interest portion is applied, the tax liability further goes up. Managing it may not be easy for all the retirees. At a time when everybody was expecting NPS to be EEE, government has made EPF similar to NPS. But, the final word on EPF taxability is still not out. It remains to be seen, how it shapes up. The gro .. The ground it seems is being prepared to popularise the NPS scheme, which after all is a market linked product compared to EPF.

Read more at:http://economictimes.indiatimes.com/wealth/tax/how-taxing-interest-portion-of-epf-impacts-you/articleshow/51226836.cms



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