PF: Compliance burden to earn more tax

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The Central Board of Direct Taxes (CBDT) has directed that employers will have to maintain two separate accounts within the PF account from 2021-22. The aim is to segregate taxable and non-taxable EPF contributions. The move is to implement the budget provision where interest income earned will be taxed on PF contributions exceeding Rs 2.5 lakh from April 2021.

Finance Minister Nirmala Sitharaman later increased the Rs 2.5 lakh limit to Rs 5 lakh, where there is no contribution made by the employer. The finance minister said in her budget speech that the provision was inserted after noticing the instances where some employees were contributing huge amounts to these funds and earning tax-free income as the income is exempted from tax under clause (11) and clause (12) of section 10 of the Act.

According to the current rules, an employee can invest up to 12% of basic salary plus dearness allowance in EPFO. The matching contribution has been made by the employer. There is also a provision of voluntary contribution, where this limit can be increased to 100%. The EPF rates are now at 8.5% lowered from 8.65% in 2018-2019.

Largely, the interest income on EPF is tax-free and no tax is levied on withdrawals after the period of 5 years. The current rule of taxing interest on contributions above Rs 2.5 lakh has been implemented to stop high-income earners from misusing the system by contributing large sums of money in EPF to earn tax-free income. Though it is a compliance burden for employers now, in the long run, it will help to check the misuse by employees who were making large deposits. The step might end up earning more revenues for the government.