What is the EPF- Employees’ Provident Fund, why salaried class considers it a trust worthy social security scheme and why government wants to make it EET? What is the rationale for making the change?
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In the Budget 2016-17, the government has proposed making 60% of Employee Provident Fund corpus would be taxable on the contributions made after 1st April 2016. The govt has categorically said that the contributions made in EPF until March 31, 2016 will attract no tax at the time of withdrawal. It will be only applicable on contributions made on or after April 1, 2016. Till now withdrawal of EPF corpus after 5 years of continuous service was fully tax exempt. The new provisions indicates that if the EPF is not used for buying an annuity then 60% of that portion of the corpus which is built from the employee contributions made from 1.4.2016 would be taxable.
What are the Tax Exemption and Taxation mechanism on Corpus:
The government tax money through three stages of investment. When any one make an investment, the money goes through three stages: (i) Contribution for an investment vehicle, (ii) When the invested money earns interest or returns and (iii) At the time of withdrawal the lump sum which is a sum of your principal and interest or return. There is a tax implication for your money at each of these stages.
EEE (Exempt, Exempt, Exempt)
Under it first exempt means that your investment is allowed for a deduction. So, you don’t have to pay tax on part of the salary that equals the invested amount. Similarly, the second exempt implies that you don’t have to pay any tax on the returns earned during the accumulation phase. The third and final exempt means that your income from the investment would be tax-free in your hands at the time of withdrawal.
EEE status is generally enjoyed by long-term investment vehicles, such as Public Provident Fund and Employees Provident Fund. However, under the revised draft Direct Taxes Code, the New Pension System will also enjoy the EEE status, but insurance-cum-investment plans and ELSS will move to the EET category.
EET (Exempt, Exempt, Taxed)
Here your money at the stages of contribution and accumulation is exempt from tax, which is explained by EE, but at the time of withdrawal, you need to pay a tax on it, denoted by T. Since your accumulation—principal plus return—is taxed at the time of withdrawal, your returns from such instruments come down, depending on your tax slabs. For instance, if you fall in the 20% tax bracket and the rate of return on your investment is 8%, you will lose out 20% of that return and make only 6.4% on your investment.
ETE (Exempt, Taxed, Exempt)
Here if you have an instrument with this status, you would have to pay a tax only on the interest component. For example, a five-year fixed deposit (FD) enjoys the ETE status, where the amount you invest qualifies for a deduction, the interest is taxed and at the time of maturity you needn’t pay tax on your principal.
So, what is the Issue?
At present, EPF is 100% tax-free because it is an exempt-exempt-exempt or EEE product, which means it is exempted from tax at all three stages of investing, accumulation and withdrawal. This will no longer be so. Government has proposed making 60% of Employee Provident Fund corpus would be taxable on the contributions made after 1st April 2016. The Union Budget 2016 has brought EPF on par with the National Pension System (NPS), as the government prepares to make NPS an alternative to EPF, as per last year’s budget announcement.
Against this backdrop, we look at what the three major retirement schemes – EPF, Public Provident Fund and National Pension Scheme. While EPF and PPF have been around for a while, the NPS has been a recent entrant and a slow-starter. However, NPS is likely to pick up steam with Finance Minister providing tax benefits at withdrawal with the long-term aim to bring parity on the taxation front with EPF. PPF, however, remains totally exempted throughout its period. For PPF, at 8.7 per cent annual rate of interest, the Economic Survey pointed out that after factoring in tax rate on deposit and interest, the effective interest rate actually comes to a high 16 per cent.
What are EPF, PPF and NPS?
EPF (Employee Provident Fund):
Eligibility: Employees drawing basic salary of Rs 15,000 have to compulsory contribute to the Provident fund and employees drawing above Rs 15,000 have an option to become member of the Provident Fund
Where to open: Scheme is provided by Employees’ Provident Fund Organisation (EPFO) through organization enrolled with it. Your office will open the account for you if they employ 20 persons or more
Investment limit: Employee contributes 12 per cent of basic salary and and equivalent amount is contributed by the Employer.
Returns: EPF funds will earn a 8.8 per cent for 2015-16, marginally up from the previous 8.75 per cent.
Duration/maturity: Till the retirement of the employee or the employee opting out of
Loans/Withdrawals: You can withdraw from EPF account for children’s education, marriage of self, children and siblings, purchase/construction of a house or any medical emergencies. However, withdrawal is subject to certain conditions:
• Minimum 7 years of service;
• Maximum 3 withdrawals during which you hold the EPF s Account;
• Maximum aggregate withdrawal would be 50% of the total contributions made by you.
For medical emergencies, there is no minimum service period. However, the maximum amount one can withdraw is 6 times the basic salary and proof of hospitalisation is required. However, withdrawal for purchase/construction of house is available only once in an individual’s working life. The minimum service period is 5 years and the maximum withdrawable amount is 36 times your total salary (for construction of property) and 24 times (for purchase of property).
Tax Benefits: Currently enjoys the Exempt, Exempt, Exempt (EEE) status. However, Budget 2016-17 has stoked a massive controversy by proposing that has proposed that only 40 per cent of the contributions made to EPF after April 1, 2016, will be tax-free on withdrawal. With widespread opposition to the move, the government is likely to reconsider its decision and a final word is awaited.
Nomination: Subscriber can nominate one or more person belonging to his family. If he has no family he can nominate any person or persons of his choice but if he subsequently acquires family, such nomination becomes invalid and he will have to make a fresh nomination of one or more persons belonging to his family. You cannot make your brother your nominee as per the Acts.
Transfer of Account: Account is transferable with change of change of job of subscriber.
Public Provident Fund (PPF)
Eligibility: Individuals can open account in their name, also open another account on behalf of a minor. Joint/NRI/HUF accounts cannot be opened.
Where to open: Post offices, public sector banks and few private banks offer the government-run scheme.
Investment Limit: Minimum Rs 500 with a cap of Rs 1.5 lakhs per annum. Deposits can be made in one lump-sum or in 12 installments per year.
Interest Rate/Returns: 8.7 per annum with effect from April 1, 2015. Interest is paid on March 31 every year. Interest calculated on monthly basis on the minimum balance between 5th and last day of the month.
Scheme Duration: 15 years with the provision to extend in one or more blocks of 5 years each. Premature closure is not allowed before 15 years.
Loans/withdrawals: Available from third financial year. Part withdrawal is permitted from 7th Financial Year
Taxation: PPF comes under the Exempt, Exempt and Exempt (EEE) category which makes it tax exempt from investment till maturity. Subscription qualifies for tax benefits under 80C of Income Tax Act.
Nomination: One or more persons can be nominated
Transfer of Account: The PPF account can be transferred free of charge to another branch, another bank or post office.
National Pension Scheme (NPS)
Eligibility: All citizens between 18 and 60 years as on the date of submission of application
Where to open: Authorised Points of Presence (POP) and almost all private and public sector banks apart from several other financial institutions offer the scheme.
Investment limit: (For Tier-1 non-withdrawable) minimum Contributions is Rs 500 with a total minimum contribution per year at Rs 6,000. For Tier-II (withdrawable) minimum contributions Rs 250 with minimum balance of Rs 2000. No cap on maximum investment.
Returns: NPS offers market-linked returns. Being a defined contribution scheme where subscribers contribute to his account, there is no defined benefit that would be available at the time of maturity. The accumulated wealth depends on the contributions made and the income generated from investment of such wealth.
Duration/maturity: Maturity of scheme is at age 60
Loans/Withdrawals: On retirement, a subscriber can opt out of NPS. However, the subscriber would be required to invest minimum 40 per cent of the accumulated savings to purchase a life annuity, while remaining can be taken out a lump-sum.
Tax Benefits: Tier-I account is exempt, exempt, taxed (EET). The amount contributed is entitled for deduction from gross total income upto Rs 1 lakh (along with other prescribed investments) as per section 80C of the Income Tax Act.
The Union Budget 2016-17 has proposed that 40% of retirement corpus of a subscriber of National Pension Scheme (NPS) at the time of retirement will be tax exempt. Further, annuity payment to the legal heir after the death of pensioner has been made exempt from tax.
Nomination: In the event of death of the subscriber, the nominee can receive 100 per cent of the NPS pension wealth in lump sum.
Transfer of Account: Provides full portability within geographies and between POPs
Why EPF is required?
The Employees’ Provident Fund is a retirement benefit scheme that was structured to provide financial security to employees of factories and other establishments post-retirement. Under it:
• 12% of the basic salary and dearness allowance has to be contributed by all employees earning up to Rs 15,000 per month (not mandatory for others), the employer component (12%) has to be contributed mandatorily in case of all employees.
• The employer’s component is split into EPF (3.67%) and the Employees’ Pension Scheme (8.33%).
It is administered by the Employees’ Provident Fund Organisation (EPFO) whose highest body is the Central Board of Trustees, with representation from the government, employers and employees. The return on EPF is decided by the government every year. For 2015-16, the government has announced a small increase to 8.8% from 8.75% for 2014-15.
What is the rationale behind it?
Announcing the imposition of tax on 60% of the withdrawal amount from EPF, the government in its Budget document argued that it was being done to bring greater parity in the tax treatment of different types of pension plans. However, in its clarification issued on Tuesday, the government said, “The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account.”
Why, it’s a good Idea?
The government says it will bring parity among provident fund, pension funds and the National Pension System (NPS). Experts say that this will allow investors to choose a product based on the returns they generate and the risk exposure they carry, and not on the basis of the tax benefit they offer. Some experts say that the government’s move will make the NPS more popular among investors, as it allows investments to be routed to equity markets that have the potential to generate higher returns. Since the money can be routed to equity markets, it will free up the capital, and can be used in the growth of the economy. Another argument put forward by the government is that the move will force employees to place the 60 per cent of the corpus in annuity for getting a regular pension.
It is also argued that Since Independence, the richest Indians have been disproportionate gainers of government subsidies and tax breaks (on cooking, automobile fuel, higher education and housing, opportunities of economic liberalization), Now, with incomes rising steadily and income-tax rates among the world’s lowest, they are in a position to be weaned off such hand-outs at a time when the government has urgent competing demands on the Budget. The government also has to and there is urgent need for government to control expenditure.
Why, it’s a bad Idea?
• This rule is applicable only to those in the private sector earning more than Rs 15,000 per month. The FM said: "The idea behind this mechanism is to encourage people to invest in pension products rather than withdraw and use the entire Corpus after retirement." Whereas if you are working with any government owned company like Coal India and investing in the Coal Mines Provident Fund, the entire corpus on maturity remains tax free. Then the question is why is a distinction being made on the basis of the employer and not the total amount of corpus that has been accumulated?
• Some experts also criticize that since 100% of the accumulated corpus can be tax free, if the private sector employee uses 60% of the accumulated corpus to buy annuities, hence it seems that it’s a conspiracy to benefit insurance companies. Annuities remain one of the worst forms of investing in India. So why are we forcing people to buy annuities, if there are better forms of investment available?
• Also, why make only EPF and other recognised provident funds taxable at maturity. Why leave out the Public Provident Fund? Shouldn’t self-employed professionals who invest in PPF to possibly accumulate a retirement corpus, also be encouraged to become part of the pensioned society?
• The government also planned to tax the principal amount invested in the EPF. How fair is this? While calculating capital gains for investments made in stocks or real estate, the principal amount is not included. Also, investments made in real estate and debt mutual funds get indexation benefits, where the impact of inflation is taken into account while calculating the cost of purchasing the asset. This brings down the capital gains on which income tax is paid.
While the government has done many flip-flop over this issue, the EPF tax issue should taken up by FM on priority basis. This issue requires amicable solution which can be reached by taking the opinion of masses and the expert of this field. Prima facie this doesn’t look like a solid idea to mobilize resources.
In the mean time when this writer was writing this piece, the pressure from the masses did work. Govt blinked, rolled back tax on EPF. In addition, the government also decided to withdraw the provision which put a monetary ceiling of Rs.1.5 lakh on employer contribution to provident fund for claiming tax benefits. However the provision allowing NPS subscribers to withdraw 40% of the corpus without any tax liability remains. This means that you pay a tax on 20% of the maturity corpus. And you pay a deferred tax on the 40% that you annuitize.