Income Tax on EPF interest for contributions above Rs 2.5 Lakhs
In Union budget 2021-22, Finance Minister has announced that there would be an income tax on EPF interest for EPF contributions above Rs 2.5 Lakhs in a year. This has created some confusion / havoc for employees who are contributing a higher amount where they are getting tax free interest. Who actually needs to pay income tax on EPF interest? Do an employee who is contributing to the EPF + VPF need to pay tax on above the threshold limit. Are there any alternative ways to invest such employee contributions?
Also Read: How Employee Provident Fund (EPF) interest is calculated?
Budget guidelines on Income Tax on EPF interest for contributions above Rs 2.5 Lakhs
Provident Fund is considered as safest retirement option by employees. Finance minister announced that if an employee is contributing to provident fund of above Rs 2.5 Lakhs in a year, income tax needs to be paid. E.g. If an employee is contributing Rs 3 Lakhs to provident fund, then they need to pay tax on interest received on incremental Rs 50K contribution (Rs 3 Lakhs minus Rs 2.5 Lakhs exemption).
Does this apply on Employee Provident Fund alone?
This would apply to all provident fund contributions made by employees i.e. EPF (Employee provident fund) as well as VPF (Voluntary provident fund).
Who would get impacted and who would NOT?
With this change, let us see who would get impacted and who would not get impacted with such change in guidelines. One should note that this tax is applied on interest received for excess employee contribution only. Employer contribution would not come into picture here.
1) Monthly basic salary < Rs 1.73 Lakhs – Contribution to EPF only
Employees who are getting monthly basic salary of Rs 1.73 Lakhs and contributing to employee provident fund i.e. 12% of Rs 1.73 Lakhs = Rs 20,760 would have annual provident fund contribution of Rs 249,120. This is within the limit of Rs 2.5 Lakhs. Hence no income tax is payable on EPF interest received on this.
2) Monthly basic salary > Rs 1.73 Lakhs – Contribution to EPF only
Employees who are getting monthly basic salary above Rs 1.73 Lakhs and contributing to employee provident fund need to pay income tax on the interest received on incremental contribution over and above Rs 2.5 Lakhs of EPF.
E.g. Assume employee monthly basic salary is Rs 2 Lakhs and employee share of EPF contribution Rs 24,000 (Rs 2 Lakhs x 12%). Annual EPF contribution is 288,000 (Rs 24,000 x 12 months). Now this is outside the limit of Rs 2.5 Lakhs (excess of Rs 38,000). Now employees need to pay income tax on the interest received on this incremental amount. E.g. if EPF interest is Rs 8% at Rs 38,000 = Rs 3,040. Income tax needs to be paid on this amount.
3) Monthly basic salary < Rs 1.73 Lakhs – Contribution to EPF + VPF
Let us take scenario-3. Many employees are contributing to VPF too to save for retirement. Employees who are getting monthly basic salary of Rs 1.73 Lakhs and contributing to employee provident fund i.e. 12% of Rs 1.73 Lakhs = Rs 20,760 would have annual contribution of Rs 249,120. Assume they are also contributing to the VPF @ 12% (as an example). With the amount contributed on the VPF + EPF, this would be Rs 5 Lakhs contribution. One needs to pay income tax on interest received for contribution done in excess of Rs 2.5 Lakhs (Rs 5 Lakhs minus Rs 2.5 Lakhs exemption). E.g. on Rs 2.5 Lakhs one is getting 8% PF interest = Rs 20,000. One need to pay income tax on such interest.
How much income tax needs to be paid on EPF interest in excess of Rs 2.5 Lakhs?
Many employees are opting for Voluntary Provident Fund (VPF) too as interest on such contribution is tax free till now. Any interest received on excess contribution of over and above Rs 2.5 Lakhs, employees need to pay income tax. Now this income tax needs to be declared and paid based on the individual tax slab. For HNI / High salary individuals / employees who are contributing to both EPF + VPF would have a huge impact with such change as they might be falling in 20% or 30% tax bracket.
EPF contribution for government employees would be done based on basic salary + dearness allowance, hence they need to consider this in their calculation.
New Wage code can affect your provident fund
Effective from 1-Apr-2021, there is a new wage code that is coming which would expand the definition of basic salary. There would be an increase in base salary whereby your EPF contribution would also increase. This would impact for employees who have higher remuneration, but lower basic salary. This is irrespective whether you are getting any salary hike from Apr-21 or not. You can be in touch with your payroll department in case there is a change in your salary structure due to this new wage code.
Also Read: Among EPF Vs PPF Vs VPF Vs NPS – Which is better?
Are there any alternatives to save tax then?
Nothing can beat EPF / VPF kind of savings where one gets safe and higher interest. If your provident fund contribution is crossing Rs 2.5 Lakhs per annum and your employer is offering NPS, you can opt for it. You can opt for fixed instruments + government securities option in NPS and avoid equity. For equity, you can have your own investment plan. This way you can generate regular returns from NPS.
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Very nicely explained Suresh. Nice work.
Thank you Shriram
Suresh ji
Nice article provided by you.
My question is
If I invest in PPF 1.5 lac and in (EPF+VPF) amount will be 2 lac for the next financial year.
In this case PPF investment will play any role. ?
Is there any tax I have to pay ??
Ankit, This rule is only for employees who are contributing to provident fund contributions (EPF and VPF). PPF contribution can be done by both employees and businessmen. Hence this would not apply for PPF.
I contribute 5 lacs to EPF this year and pay tax on interest earned. next year I contribute only 2.5 lacs….but will earn interest on the excess amount paid last year…so next year also do i need to pay tax on interest income of previous year contribution…
the rule is simple. If contribution during the financial year excees Rs 2.5 lakshs tax needs to be paid on interest. In your example, if 2nd year the contribution is only Rs 2.5 L, then no tax needs to be paid
I think the rules are very clear.
You have to pay tax (at your marginal tax rate) on the interest earned on the excess contribution (i.e. over and above Rs. 2.50 lakh in a year). There is no further tax in next year on this opening balance.
Next year also, if you contribute more than 2.50 lakhs, then, again tax on interest earned on this excess contribution is taxable.
For example, your current year’s contribution (PF+VPF) is say, Rs. 4 lakhs. On this addition 1.5 lakh, @ 8% interest , you earn, Rs. 12,000 as addition interest, so you pay marginal tax on this 12,000 interest which you earned. Now, next year, your opening balance is Rs. 4.32 lakhs (add interest @ 8% on 4 lakhs) and interest earned on 4.32 lakhs is Rs. 34,560, which is completely tax free. If next year, again your contribution is more than Rs. 2.50 lakh, then, against, you pay tax on interest earned on additional contribution.
That’s all.
From the logic which FM gave, it does not seem to be this simple.
They just dont want HNIs to take benefit of this tax exempt income. so why would they tax (interest on excess amount of 2.5L) only for 1st year and not for subsequent years?
Is this additional tax payable even if annual interest earned exceeds 2.5lakhs, with no additional monthly contributions to epf?
No. This is applicable only if there are contributions during the financial year and which is in excess of Rs 2.5 Lakhs only.
Thank you very much, Mr Suresh. It is not clear if it will be commulative. Assume that one earns interest of 10000 on excess amount. During first year, he will pay 1000/- as tax assuming 10% bracket. For next year, will the interest on 1000/- be counted in income or not?
Ashwani, In your example, answer is NO.
However you might have done fresh contribution in next year which is in excess of Rs 2.5 Lakhs and there could be interest. In such case tax needs to be paid on that. It is obvious that in year-1 if there is excess contribution in EPF (over and above Rs 2.5 Lakhs), it might be there in year-2 too unless employee has resigned or opted out lower amount (e.g. EPF + VPF there, but VPF contribution is reduced in next year)
Thank you sir. It is clear