EPF interest taxation: Here’s how TDS will be calculated on interest earned on contribution beyond Rs 2.5 lakh

Harshita jain


New Delhi: Budget 2021 left some taxpayers unsatisfied as there were no rate cuts or standard deduction limit hike. This Budget has left income-tax rates and slabs unchanged. While the Finance Minister did not announce any hike in super-rich surcharge, she found a way to tax the rich and super-rich by taxing the interest earned on Employee’s Provident Fund (EPF) contributions in excess of Rs 2.5 lakh in a financial year.

The finance ministry has not yet clarified how exactly the interest would be computed and taxed. However, it is clear that if your EPF and voluntary provident fund (VPF) annual contributions go beyond Rs 2.5 lakh, then the tax on interest will be the same as the income tax rate (including surcharge, if any) applicable to you.

Note that the government’s move to tax interest earned over Rs 2.5 lakh annual contribution to provident fund faced huge criticism following which the Centre said that the benefit of high tax-free returns was accruing to high net worth individuals (HNIs) though PF was meant for workers. Among HNIs, the highest corpus that one individual has in his PF account is Rs 103 crore followed by one holding Rs 86 crore.

The top 20 HNIs have a balance of Rs 825 crore in their retirement fund while the top 100 have a balance of Rs 2,000 crore, a ToI report mentioned citing official sources.

How TDS will be calculated:

While no details have been shared by the tax department or government so far as to how TDS will be applicable on interest earned on contributions above Rs 2.5 lakh, calculations show that if an individual’s annual basic salary is close to Rs 21 lakh or more, they will come under the EPF tax net.

For instance, if an individual’s annual basic pay is Rs 22 lakh, it would mean that they would have contributed Rs 2.64 lakh (12 percent) to EPF, Rs 14,000 above the annual Rs 2.5-lakh tax-exempt threshold. Assuming 8.5 per cent payout – which is the interest rate on EPF – the interest earned on the excess Rs 14,000 will be Rs 1,190. For those falling in the 30 per cent tax bracket, an amount of Rs 371 (30 per cent tax plus 4 per cent cess) will also have to be paid.

Aarti Raote, Partner, Deloitte India, explained, “This amendment would impact employees having a PF salary (i.e. Basic + DA+ Retaining allowance) in excess of Rs 20 lakhs and if we presume that this is at least 50% of the employee’s total remuneration, then his total salary would be in the range of Rs 40 lakhs or more. Hence such employees would need to face the tax cut on interest earnings going forward. Thus while the PF scheme is still attractive for the lower-income group, it does take off the sheen for the higher income group.”.

The first Rs 2.5 lakh contribution will earn 8.5% tax-free interest for next year as well assuming EPF interest rates remain unchanged. If your EPF contributions increase to Rs 3 lakh, the post-tax interest yield from EPF will be 8%. As per reports, EPF returns will fall to 5.7% if annual contributions to EPF and VPF together remains between Rs 36-48 lakh, assuming the taxable income of the individual is close to Rs 1 crore but not beyond it.

The tax on interest for such individuals will be 30% plus 10% surcharge. For contributions of Rs 60 lakh, it has been assumed that income of the individual is between Rs 1 crore and Rs 2 crore, which attracts 30% tax along with 15% surcharge. High contributions of Rs 1.2 crore annually, assumed to be in the Rs 2-5 crore income slab (30% tax plus 25% surcharge), and Rs 2.5 crore annually, assumed to be earning above Rs 5 crore (30% tax plus 37% surcharge).

According to Kush Vatsaraj, Associate, TP Ostwal & Associates LLP, “The proposed amendment will not affect anyone making contributions to PPF accounts since there is already an annual cap of Rs 1.5 lakh. Salaried persons who make contributions to their PF scheme in excess of Rs 1.5 lakhs per annum will also not be affected since they can only claim a deduction of up to Rs 1.5 lakh under section 80C, and the excess contribution is already taxable as salary income.”

“However, it is seen that high-salaried employees are making huge contributions to their PF accounts, even though their contributions are taxable beyond Rs 1.5 lakh per annum (under section 80C). This is because the interest accrued on the entire contribution is still exempt. This amendment seeks to reduce such disproportionate benefit, and going forward even the interest income earned on the amount contributed in excess of Rs 2.5 lakh will be taxable. To reiterate, this amendment applies only to interest income on the amount of contribution in excess of Rs 2.5 lakh by salaried persons as part of their PF scheme and does not affect PPF contributions,” he explained.

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