However, Budget 2021 amended the said section to withdraw the tax exemption for interest on employee’s contribution to PF, where such contributions exceed Rs 2.5 lakh in a financial year. Such interest on employee’s contribution to PF is taxable under the head ‘Income from other sources’.
Subsequently, on August 31, 2021, the Central Board of Direct Taxes (CBDT) notified the new rule 9D under the Income-tax Rules to prescribe the methodology to compute such taxable interest. The Rule provides the following:
a) Separate EPF accounts will need to be maintained for taxable contributions and non-taxable contributions made by an employee, i.e., contribution made by an employee over and above the threshold will be maintained in a separate EPF account.
b) ‘Non-taxable EPF contribution account’ will be aggregate of the following:
i. Balance in employee’s EPF account as on 31 March 2021
ii. Employee’s contribution made during the Financial Year 2021-22 and future years, within the prescribed threshold of Rs 2.5 lakh
iii. Interest accrued on the above, as reduced by withdrawal, if any, from the EPF account
c) ‘Taxable EPF contribution account’ will be aggregate of the following:
i. Employee’s contribution made during the Financial Year 2021-22 and future years, exceeding the prescribed threshold of Rs 2.5 lakh
ii. Interest accrued on the above, as reduced by withdrawal, if any, from the account
The interest accrued in the taxable contribution account will not qualify for tax exemption.
The income tax rule also clarifies that the withdrawal of income tax exemption is prospective (from April 1, 2021) as it grandfathers any interest on balance in EPF account as on 31 March 2021 by including it as a part of the ‘non-taxable contribution account’.
In addition to the Employees’ Provident Fund Organisation (EPFO), all Private Provident Fund Trusts will also need to implement this requirement and maintain separate accounts for taxable and non-taxable contributions made by employees.
While the tax rule provides clarity on calculation of such taxable and non-taxable contributions, there is still ambiguity on some aspects:
a. Point of taxation of such interest on employee’s excess contributions to EPF – Whether such interest is taxable in the hands of employees only in the year of termination of employment or whether it will be taxable on a year-on-year basis?
b. Withholding tax (TDS) obligation for employer or Private PF Trusts on such taxable interest – As per the Income-tax Act, the obligation to deduct TDS on Private PF Trusts exists only under limited circumstances, like termination of employment before completing 5 years continuous service. There is no specific requirement in the income-tax law requiring such Trusts to cut TDS on credit of interest to the ‘taxable contribution account’. Further, since such interest is not taxable as ‘salary’ income, the employer also may not have any obligation to deduct TDS.
However, on April 5, 2022, the EPFO issued a circular providing guidelines on computation of taxable interest and obligation to deduct TDS. The EPFO has clarified that TDS will be applied at the time of credit or payment of interest, whichever is earlier.
The added complexity for individuals is that the EPFO is yet to credit interest for the Financial Year 2021-22 in employees’ EPF statements. Because of this, individuals will not be able to offer interest on taxable contribution account for taxation while filing their personal income tax returns for the Financial Year 2021-22, which is due for filing by 31 July 2022.
For individuals who are covered under Private Trusts, if the Trust has deducted TDS on interest on taxable contribution account and reported that in employee’s Form 26AS – the individual will have no choice but to report such interest in personal tax return. However, it may be debatable whether such interest is taxable on year-on-year basis or only on termination of employment.
This ambiguity may need to be addressed by the CBDT by making appropriate amendments or issuing necessary clarifications on:
a. Timing of taxation in the hands of employees; and
b. Requirement and timing of deduction of TDS on such taxable interest
(The writer is a Partner in EY India)