Budget 2021 Caps Tax-Free Returns On Provident Fund. Here’s What You Need To Know.
Budget 2021 capped tax-free interest that employees can earn on their contributions to the provident fund.
From April 1, those contributing more than Rs 2.5 lakh a year to the EPF will have to pay tax on the interest earned on the amount above that limit. For example, if an individual contributes Rs 3.5 lakh to the EPF in the financial year through March 2022, the interest earned on Rs 1 lakh will be taxed based on the employee's income tax slab.
Who's At Risk Of Crossing The Limit?
There are two ways that the Rs 2.5 lakh limit can be breached. Assuming a contribution of 12% of basic salary, an employee earning more than 20.8 lakh a year in basic salary will breach the cap. Also those who have chosen to voluntarily bolster their contributions to the EPF can also cross the limit. Employees are allowed to increase their contributions through the Voluntary Provident Fund on the condition that it shouldn't be more than 100% of the basic salary.
Is There A Way Around It?
Those voluntarily contributing more to EPF can choose to invest the amount above Rs 2.5 lakh elsewhere if their goal is to reduce tax, said Arvind Rao, certified financial planner and founder of Arvind Rao & Associates.
New labour laws mandate that the basic salary has to be at least 50% of the cost to company. And if that 50% is higher than Rs 20.8 lakh a year, the employee has only one option—to cap basic salary at Rs 15,000 per month for computing EPF contribution, Rao said. That law mandates compulsory PF deductions for those with basic salary of up to Rs 15,000.
But this option has a drawback. Employers match an employee’s contribution to the EPF up to 12% of the basic salary. In this case, the employer’s contribution would also be capped to 12% of 15,000. The remainder, which would have gone into the EPF, will be taxable salary.
However, those narrowly breaching the threshold could enquire whether their organisation can make a contribution on their behalf to the National Pension Scheme. Such contributions are capped at 10% of the basic salary but could potentially bring an individual’s basic salary below Rs 20 lakh.
Should You Look For An Alternative?
The short answer, according to Rao, is no. The EPF remains one of the safest, highest-yielding investment options available to individuals. "We will have to accept that we’re moving in a direction where the returns of all investments will be taxed beyond a point,” Rao said.
If an individual is making voluntary contributions through the VPF route, based on their risk profiles, they could choose to make investments into equity and debt securities. For equity investments, capital gains beyond one year are treated as long-term and attract a 10% tax. Long-term capital gains on debt mutual fund investments kick in after three years. These gains are taxed at 20%, but with indexation benefits, which adjust the gains for inflation during the holding period.
Watch the full conversation here:
(Corrects the graphic that misstated the amount on which tax will be charged)