Rules for taxing interest on focused provident fund: fiscal year 2021-22:- all you need to know.

Provident fund taxes: If you have followed this year’s budget, you would probably know that the finance minister has introduced a lot of new policies in this year’s budget. Further, the budget also made plans of the government clear that this year, more focus will be given to infrastructural development.

However, as we all know, infrastructural development requires huge funds and the major source of funds for the government is taxes, right? Therefore, the government has introduced many new policies and taxation schemes in order to fund the growing infrastructural demands. In this article, we will be discussing one such newly introduced policy of the government and what will be its effect. By the end of this article, you will have a clear view of everything related to that policy. 

What is the new policy on provident fund? 

The government of the country has recently notified the rules for taxing the interest received on provident fund contributions beyond the limit. It is followed after the announcement of it was done in the month of February when the budget was introduced.

According to the rules, the tax will be imposed on the interest earnings from the Employee’s Provident Fund beyond the limit of Rs 2.5 lakh for private-sector employees and Rs 5 lakh for government sector employees. Beginning from this fiscal, the government will tax every individual on the contribution made in excess of these limits and will maintain a separate account within the provident fund account.

This will be done for the fiscal year of 2021-2022 and all the subsequent years for the contribution made by any individual. 

What are the changes, if any? 

In the month of February, the government announced that there will be no exemption on the tax for contributions made above the amount of Rs 2.5 lakh. Interest in earning beyond this level of contributions will be taxed. However, it posed a concern for all those individuals who are salaried and are contributing to Employee’s Provident Fund.

The government further claimed that this scheme will not at all impact the existing corpus or the aggregate interest on that. 

However, things changed quite a bit in the month of March when an amendment was introduced. The government introduced an amendment in the finance bill of 2021, in which it proposed to double the limit of contribution from 2.5 lakh to 5 lakh for tax exempt interest income, only if the contribution is made to fund where there is no contribution by the employer.

With this amendment, the government provided relief to the contributions made to the General Provident Fund which is available only to the government employees and therefore there is no contribution by the employer. However, there is no such amendment for the privately employed individuals and therefore the limit for them is still Rs 2.5 lakh, hence no further relief for them. 

What are the rules to enable this scheme? 

The rules regarding this scheme of taxation were notified by the Finance ministry of the nation on August 31. It is an amendment made to the Income Tax Rules of 1962 which will come into effect from the 1st of April, 2022.

The new rule inserted in the rule 9D according to which income earned through accrued during the previous years and is beyond the limit allowed ( Rs 2.5 lakh for private and Rs 5 lakh for public) should be considered as interest accrued in the previous years under the taxable contribution account.

Separate accounts under the provident fund account shall be maintained for an individual’s taxable we as non-taxable income. The rule is said to be applied for the financial year of 2021-2022 and all the subsequent years. 

However, whenever new rules are introduced, it takes some time for their proper implementation. The EPFO, according to reports, is yet to formalise the separation of the taxable and non-taxable contribution in the accounts of people.

According to some EPF board members, this task of separation is not an easy job and therefore it will take time. Why is it time consuming? It is time consuming as firstly the data has to be aggregated and then a separate accounting process has to be determined for such accounts.

Therefore, all of this takes a lot of effort and will take some time. 

Moreover, the closing balance as of 31 March 2021 and the interest accrual on it will be treated as a non taxable component. Moreover, the taxable contribution account will include all the contributions made by an individual in the year 2021-22 and subsequent years which are in excess of the threshold limit. 

What was the actual need for this proposal? 

The budget proposal had noted that the government has seen in many cases that some employees pay a huge sum of money towards the contribution and therefore get the benefit of tax exemption.

This benefit of tax exemption is enjoyed by them at every level- contribution, interest accumulation and withdrawal. Therefore, in order to remove the High Net worth Individuals from the benefit of tax-free income on their huge contributions, this threshold limit for tax exemption has been proposed by the government.

Therefore, it will act as a source of income for the government as well as will ensure fair practice in the economy. This will be applicable for all the contributions made beginning from 1st April 2021.

If you are wondering that this may harm the workers,

You are wrong. This is rather done for the benefit of the workers. According to our finance minister, this proposal will not harm the workers. According to Ms Nirmala Sitharaman, this proposal is only for the big ticket money which comes only because it has tax benefits and is assured with the 8% returns. So, for a huge salaried individual getting tax concessions and 8% returns, it is not fair for an individual having a salary of Rs 2 lakh. 

What is the tax procedure? 

As per the rules being notified recently, the interest income on additional contribution over the level of Rs 2.5 lakh and Rs 5 lakh for private and government employees respectively for a year will be taxed every year. In layman language, if an individual makes an annual contribution in the provident fund of Rs 10 lakh, the interest income of Rs 7.5 lakh will be taxed for not just the financial year of 2021-2022 but for every subsequent year.

Moreover, if the individual receives an interest of 8.5% last year and falls in the highest tax bracket category, he will receive an interest of 5.85% of the additional contribution this year. 

The rules have been recently rolled out and are slightly confusing to understand at once, they will become simple later on. According to our finance minister, it is done only for the benefit of the workers and there is no chance that they will get hurt by it.

New policies are made every day, and in a country like India which is developing daily, it becomes a necessity. This new policy will act as a great source of income for the government as the tax revenue contributes to the majority of the total revenue of the government and it is also expected that this will help reduce income inequalities in the country. 

Edited by Sanjana Simlai.