Finance Bill 2020 has proposed that contribution above 2.5 lakhs by employees into recognised provided funds will be taxed. If an excess contribution is made in one financial year, will it be taxed only in that year or in subsequent financial years until maturity or withdrawal?
While a precise answer to this is not available (clarification is awaited and the article will then be updated) arguments that suggest that such an excess contribution will be taxable every year is presented below. To accommodate these arguments, we have now updated the taxable EPF Interest calculator published earlier today.
Is the interest earned on excess PF contribution (>2.5 lakh) taxable in future financial years also? I was under the impression it is not, but many disagreed with me. These are the exact words of the finance bill 2021 (page 34)
“Provided that the provisions of this clause shall not
apply to the income by way of interest accrued during the
previous year in the account of a person to the extent it
relates to the amount or the aggregate of amounts of
the contribution made by that person exceeding two lakh and
fifty thousand rupees in any previous year in that fund, on
or after the 1st day of April 2021 and computed in such
manner as may be prescribed;”
This can be interpreted as “interest earned on contributions made above 2.5 lakh in one financial year will be taxed in every subsequent year after 1st April 2021 until maturity”
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This means: Suppose a person invested Rs. 50,000 extra in a recognised PF. For 8% PF rate, the interest in the FY year of investment is Rs. 4000 (this depends on which month the amount is invested as shown in the calculator but we will keep it simple here)
In the next financial year if no extra contribution is made, this Rs 50,000 + Rs. 4000 =.Rs. 54,000 will earn an interest of Rs. 4320. If the above interpretation (sentence in red) is correct, then this Rs. 4320 will also be taxable. Interest earned in subsequent financial years will also be taxed. This is an illustration shared by Manmohan Sethumadhavan (Manu). If this interpretation is correct then, users can refer to the additional sheet added to the calculator based on Manu’s sheet. Download the taxable PF contribution calculator (uploaded 3rd Feb 2021) For feedback or bugs write to freefincal AT Gmail.
Manu adds the following points:
- Section 10(11) and 10(12) are clauses exempting some income to be taxable without any limits.
- The words (in the finance bill quotes above) are provisos to both clauses restricting that exemption.
- So, if read together with the proviso, “the “exemption” shall not apply for interest accrued during the previous year (i.e., the concerned FY), if it is related to a contribution in excess of 2.5L in any previous years”.
- Now, in a case of a contribution of 3L, the interest for 50K is taxable. No doubt.
- The next FY, the interest accrued on that 50K should be taxable, as it “relates” to the excess contribution made in some previous year. And it goes on.
- This is not double-taxation, as it is the interest separately accrued in the next FY on some previously accumulated interest, which is the same in case of FDs also.
- So, as per my understanding, there should be 3 separate portfolios for EPF from now on. 1. Employer’s contribution, 2. Employee’s contribution below 2.5L each year, 3. Employee’s contribution above 2.5L each year.
- This should compound separately. And interest accrued every year in portfolio-3 is taxable and the rest is exempt (see illustration pdf linked above).
- According to section 10 of the IT act: In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included
- (11) any payment from a provident fund to which the Provident Funds Act, 1925 (19 of 1925), applies or from any other provident fund set up by the Central Government and notified by it in this behalf in the Official Gazette;
- (12) the accumulated balance due and becoming payable to an employee participating in a recognised provident fund, to the extent provided in rule 8 of Part A of the Fourth Schedule ;
- So, what I understand is 10(12) stands for interest accumulation and 10(11) for withdrawal or superannuation. If a proviso is inserted to both subsections, both incidents are taxable.
In summary, it is quite likely that the interest from the excess contribution will be taxed every financial year, but clarification from the government is necessary.
Update: The Central Board of Direct Taxes has now confirmed that the interest is taxable every year
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