EPF taxation a regressive step

Last week in an annual ritual of requests, suggestions and wishes, most commentators expected certain provisions in the Union Budget especially in the personal income tax related issues. The foremost being the increase in the basic slabs of taxation along with the increase in the various sections of the savings especially with regards to the children tuition fee and also the interest on the first house purchase. In similar vein, the suggestions were ranged upon the exemption or provisions for retirement-oriented investments and products.

This brings the National Pension Scheme (NPS) into the spotlight which has a lock-in till age 60 while the returns are taxed and are treated at par with any traditional pension plan. Most observers and experts wished the NPS gets its due credit considering the emphasis by the current govt. upon the post-retirement life of the citizens. There was an anomaly in terms of the tax treatment when compared with the other long-term retirement savings like Employee Provident Fund (EPF) or Public Provident Fund (PPF) where savings from these investments are treated as tax-free while that of the NPS are not.

Though, the NPS comes with a flexibility of investing in equities (maximum to 50 per cent), debt with varying degrees, also with a life stage allocation method and also a very minimal cost (when compared to other retirement products) the taxable nature has not helped gain momentum. In the previous budget, the govt. has introduced an additional provision in the tax structure to get deduction other than the existing Sec 80(C). This has raised hopes in the common investors for a further increase or better of this deal in this budget. Contrary to the expectations, the Finance Bill of 16-17 however didn’t make the popular and necessary change.

While maintaining a status quo on the NPS tax structure, the government has moved the EPF at par with the NPS. However, instead of making NPS tax exempt at the time of withdrawal, the government has made the EPF partially taxable. This has not only discouraged the NPS investors but also robed EPF (in most cases a mandatory in formal employment) its sheen. Thankfully at least, the taxation on the EPF is not retrospective. The tax is applicable only on the contributions made and the interest accrued on those from April 1 onwards.

The Finance Minister (FM) has given clarifications on this matter in the post-Budget announcements, though sticking to the original plan of part-taxing the EPF withdrawals, despite a formidable backlash and protests from various quarters.

The clarifications are:
1. Only forty per cent of the withdrawals (EPF corpus) from each scheme will be tax exempt, unlike the 100 per cent existed earlier.
2. 60 per cent of the EPF corpus will be treated as income if it’s not invested in an annuity offered by an insurance company. However, again the subsequent income from the annuity will be taxed (this has been the practice).
3. The new taxation will be only applicable for contributions to the EPF account after April 1. The current contributions, accumulated corpus and its further accumulation (interests accrued in future) will be exempt from tax.
4. No taxation on the original corpus at the hands of the heir in the instance of the death of the annuity holder.
5. The tax treatment of this 60-40 is applicable even on the voluntary EPF contributors in case the individual is not opting for the annuity at the time of withdrawal.
6. No change in the PPF taxation treatment.
7. Ceiling of Rs 1.5 lakh contribution by the employer and 12 per cent of the basic, whichever being lesser.
8. Under consideration is however, the request to consider only the accumulated returns on the corpus for the tax treatment and not the corpus as a whole.
9. This is however not applicable for those earning less than Rs 15K per month.

The response from the government on these changes is still unclear except for a broad reform in taxation as an explanation. The problem is not acute due to the tax treatment but the options that are left with the investor. As such, the traditional annuity plans provide little real returns and the receipts from these are deemed income, so are taxed. These monies are at the first place are accumulated through EPF, which is again a not-so-great source of accumulation as their real interest rate is again negligible.

Though, the FM says that the taxation is applicable only those withdrawals which cross the threshold limits (as per the tax slabs), most would be liable to tax as these withdrawals would be in bulk and could end up on the highest tax bracket in that particular year even for the low-income savers.

So, if the government is too worried and concerned about the PF kitty being squandered by the citizens, then it could tweak the PF withdrawals to more stringent laws if done for other than retirement, etc. and not penalize everyone. The reaction from the general public is angry and disappointed, rightly so!

(The author is a practising financial planner and could be reached at [email protected])