In this article, we address a popular misconception about the contribution of NPS employers. Before we begin, we would like to point out that your employer is most likely handling this contribution correctly. The misconception is only among the employees.
The NPS employer’s contribution falls under 80CCD(2) and is separate from the 80C limit of Rs. 1.5 Lakhs. This contribution is 10% of salary (Basic + DA) (14% for state and central government employees) and is deductible from taxable income up to 7.5 Lakh. Beyond this, it is taxable per slab. The same tax-free limit also applies to EPF.
For the NPS employee contribution to be deducted from taxable income, it must first be added to the taxable income!
Suppose an employee has a salary of Rs. 12 lakhs per year (to keep things simple, we assume this is just basic + DA). The NPS employer contribution on this is Rs. 1.2 lakh.
The total taxable income now is Rs. 12 + Rs. 1.2 = Rs. 13.2. Now, you apply section 80CCD(2) and deduct the Rs. 1.2; the net taxable income is now Rs. 12 lakhs.
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You cannot deduct Rs. 1.2 lakhs from Rs. 12 lakhs and claim I have “additional tax benefits” from NPS employer contributions! The NPS employer contribution is part of an employee’s salary and taxable income, which is why there is a tax deduction for it. So you add the contribution to the salary and then apply the deduction.
So first, you have “additional” taxable income from the employer contributions, and then you have an additional tax benefit to nullify this! The actual benefit is a tax-free contribution to our NPS accounts. If we wish to view these as a tax deduction, we must appreciate that we include them in the total salary and then apply the deduction!
This confusion does not arise with EPF employer contributions because they are not part of the salary and taxable income. This is why it does not matter whether you follow the new or old tax regime. Meanwhile, for NPS, the government has to specify that employer contributions are still valid in the new regime.
The right way to appreciate EPF or NPS contributions is to recognise that we get tax-free employer contributions in our account. This way, there is no confusion.
We want to reiterate that your employer is most likely handling this contribution correctly. The misconception is only among the employees.