It has been proposed in the Union Budget 2021 to tax the employee`s Provident Fund (PF) contribution. The employee`s PF contribution in excess of 2.50 Lakhs per annum will be taxed. Suppose an employee contributes more than 2.50 Lakhs per annum towards Provident Fund (PF) or Voluntary Provident Funds (VPF). In this case, the interest earned on the additional amount (more than 2.50 Lakhs) would be taxable. Please note that the limit of 2.50 Lakhs per annum is for employee contribution. The amount contributed by the employer would not be taxable (Unless it goes beyond the permissible limit of 7.50 Lakhs per annum).
New PF Rules 2021 – Example
Let me give you an example of the New PF Rules – Suppose you are contributing 3 Lakhs per year (25,000 per month) in the PF account for FY 2021-22. The interest rate declared on PF is 8% for FY 2021-22. The total interest earned on this amount of 3 Lakhs would be 24,000. It must be taken into account that the interest earned is tax-free upto the contribution of 2.50 Lakhs. This simply means that there would be no tax on PF interest amount of 20,000. The additional amount of 4,000 would be added to your tax slab and taxed accordingly. Let us see the calculations.
Employee`s annual contribution towards PF account – 3,00,000
Interest of 3 Lakhs (assuming 8% interest rate) – 3,00,000 * 0.08 = 24,000
Tax Free Interest on PF account – 2,50,000 * 0.08 = 20,000
Tax on PF interest (more than 2.50 lakhs) – 24,000 – 20,000 = 4,000
Kindly note that this amount of 4,000 would also be subject to TDS at 10% (i.e., TDS of 400 would be deducted in the above example).
Also Read : 4 Unusual Ways to save Tax
Tax on PF Interest – Existing Rules
As per the existing rules, there is no tax on PF interest.
Tax on PF Interest – New Rules
As per the new rules, tax on PF interest would be applicable from 1st April 2021. It would be applicable if the employee`s contribution is more than 2.50 Lakhs per annum.
Note that the rule will come into effect from 1st April 2021. Therefore, the existing accumulated amount in the PF account till 31st March 2020 would not be taxable.
Suppose you have 50 Lakhs in your PF account till 31st March 2021 (including employer and employee contribution). This interest earned on this amount of 50 Lakhs would be tax-exempt in the future too.
The interest earned will be taxable under the head ‘Income from other sources’.
The interest component will also be subject to TDS under Section 194(A).
The additional interest income will be added to your total income of the year. Then, it will be taxed as per your tax slabs.
How Does Tax Work On PF Interest – Calculations
Tax of PF will work the in the same way as interest earned on Fixed Deposits in Bank.
Suppose you are contributing 3 Lakhs per annum in your PF account for FY 2021-22. The interest payable on 50,000 (more than 2.50 Lakhs and assuming 8% interest rate) would be 4,000. (For FY 2021-22.)
After paying tax (assuming tax rate of 20% and ignoring cess), you would be having 3,200 as interest earned. i.e., total of 53,200.
Suppose you contributed additional 50,000 in your PF account (more than 2.50 Lakhs) in the next financial year. Here, the total interest earned would be counted as follows:
Previous year’s amount + Current Year amount i.e., 53,200+50,000 = 1,03,200
Assuming 8% interest rate declared by the Government, the taxable interest would be 8,256 (1,03,022*0.08). And, it would be calculated in the same way till maturity.
New PF Limit of 5 Lakhs for Tax Exemption
New PF tax exemption limit was raised to 5 Lakhs by Finance Minister Nirmala Sitharaman on Tuesday This new PF limit of 5 Lakhs is only for defined cases where employer does not contribute towards provident fund. Some of the example where the employer does not contribute any amount towards Provident funds are as follow:
- DSOPF – The new limit would be applicable for Defence Services Officers’ Provident Fund (DSOPF)
- GPF – The new limit would be applicable for Government Provident Fund (GPF)
In both the cases mentioned above, PF tax exemption limit of 5 Lakhs would be applicable.
Do You Have Any Alternative?
Suppose your mandatory employee PF contribution (12% of basic salary) is more than 2.50 lakhs per annum. Frankly speaking, you can not do much about it. You will have to pay the taxes.
Suppose your mandatory contribution is less than 2.50 lakhs per annum but you’re contributing an additional amount towards VPF. In this case, there is an option. You can divert the additional amount towards the PPF account if you do not have a PPF account already. There is a second option of NPS account as well. With this account, you can divert 50,000 per annum and get additional tax benefits too.
Some employers also give an option to split the amount in PF and NPS. You can divert the additional amount towards NPS if you are lucky enough to get this option from your employer.
The final option is to divert your funds to debt mutual funds. But would you really want to do this? Well, it is completely up to you. Even with a 30% tax slab rate and current interest rates of 8.50% on PF account. You would be earning an interest rate of 6% and that too tax-free.
At last, the choice is all yours. Do let me know if you have any queries by dropping your thoughts in the comment section below.