EPF tax rules- Social Security

GS-Paper-3: Economic issue and Economics Optional – UPSC PRELIMS – Mains Application

Context: The new EPF tax rules will come into effect from April 1, 2021, as announced in the Union Budget of 2021. Highly important for UPSC-PRELIMS and EPFO examination.

For EPFO PREPARATION: https://www.aspireias.com/upsc-epfo

Free SOCIAL SECURITY Booklet: https://www.aspireias.com/uploads/upladfile/Social_security_(2).pdf

Existing rule?

If a person contributes more than the limit prescribed under Section 80C of the Income Tax Act, he cannot get a tax break on his excess contribution. The earnings on contributions rarely suffered taxation since tax laws pegged tax-free earnings to higher rates than the interest rate on the EPF.

Moreover, the person will pay tax on their corpus, only if he withdrew it within 5 years from the comment of the contribution. This taxation framework incentivised employees to use the EPF as their primary retirement savings and it acted as a risk-free retirement savings mode.

What is the new rule?

• The new tax regulation will label a person as a high net worth individual if he misuses EPF by contributing more than Rs 2.5 lakh per annum to the EPF.
• The limit is Rs 5 lakh in cases where employers do not make contributions to the provident fund.

What is the issue with new rules?

• With the new rule coming into effect, the government assumes what is adequate for an individual on retirement.
• The decision on a common threshold of adequacy is incorrect and suffers from the flaw of a one-size-fits-all approach.
• Moreover, the word ‘misuse’ that was used to justify the imposition of the tax is difficult to comprehend.
• This is because EPF is solely a payroll deduction and cannot be contributed in any other manner.

• The new clause of taxing the amount exceeding the limit prescribed in the act brings the EPF to the borders of double taxation.
• 65% of EPF is invested in government securities and the rest is invested largely in PSU bonds and earnings available to the employee through the interest credit mechanism.
• Despite the stickiness of these interest rate declarations and there often being higher than market rates, it is certain that the government does not subsidise this interest rate credit.

Why it is difficult to administer?

• In addition to these flaws, there are difficulties in administrating the new tax rule.
• Due to the change of the threshold from Rs 2.5 lakh to Rs 5 lakh, there can be various interpretations surrounding the applicability to EPF.
• It is also unclear if the interest on such excess contributions is taxed once during the year of contribution or throughout the term of investment in EPF.
• The mechanism of tax communication from the EPFO to the member also remains uncertain.

Important Points

• The EPF remains a subsidy-free, pay-what-is-earned retirement fund and typifies safety with governance.
• Though pension funds are seen by governments in multiple policy contexts, they should remain, foremost, the retirement funds of the beneficiaries.

• Regulations governing contributions, taxation, investments, administration and benefits should be made in the interest of the beneficiary.
• But it seems that other imperatives dominate the agenda in pension policymaking in India.
• Therefore, the resultant outcomes are sub-optimal from a beneficiary point of view.
• Therefore the policymakers need to relook the new rules and the immediate rollback of it demonstrates the will of the policymakers to encourage retirement savings.