Tax on Contribution to PF and interest exceeding the taxable threshold will not be retrospective: CBDT

In order to provide clarity on the computation of the taxable interest component, CBDT vide its Notification dated 31st August 2021, has provided a mechanism to facilitate the computation of taxable interest for the financial year 2021-22. According to the notification, the mechanism of segregating taxable and non-taxable contributions requires maintenance of separate accounts within the provident fund account for the financial year 2021-2022 and subsequent financial years wherein taxable contribution and the non-taxable contribution shall be maintained. For this purpose, balance as of 31 March 2021 and non-taxable contribution made during FY 2021-22 and subsequent years (contributions which are less than Rs2.5 /5 lakhs along with interest component accrues on the above are treated as non-taxable contribution). The contribution amount exceeding the taxable threshold limit along with interest on the above will be separately recorded as a taxable contribution. The calculation will be undertaken after factoring in the withdrawals if any.

The CBDT notification stated that these rules will come into effect from April 1, 2022. Thus, tax on the interest earned on excess contributions in FY 2021-22 will be payable by the employee and he needs to declare it in his next year’s income tax return filing.

As per CBDT notification dated August 31, 2021;

(a) Non-taxable contribution account shall be the aggregate of the following, namely:- (i) closing balance in the account as on 31st day of March 2021; (ii) any contribution made by the person in the account during the previous year 2021-2022 (i.e. previous year is current financial year as per income tax parlance) and

subsequent previous years, which is not included in the taxable contribution account; and (iii) interest accrued on sub-clause (i) and sub-clause (ii), as reduced by the withdrawal, if any, from such account; (b) Taxable contribution account shall be the aggregate of the following, namely:- (i) contribution made by the person in a previous year in the account during the previous year 2021-2022 and subsequent previous years, which is in excess of the threshold limit; and (ii) interest accrued on sub-clause (i) as reduced by the withdrawal if any from such account.

As per current law, effective from April 1, 2020, onwards, the employer’s contribution to the EPF account can become taxable if it exceeds Rs 7.5 lakh in a financial year. The excess contribution will become taxable in the hands of an employee. In case there is no employer contribution to the EPF account, which is usually the case for government sector employees, then interest will be tax-exempted for the employee’s own contribution up to Rs.5 lakh in a financial year.

The EPF contribution is credited to the EPF account on a monthly basis, and interest is computed every month. However, the total interest for the year will be credited at the end of the financial year. Interest for the FY 2019-20 is 8.5%. Hence, for every month interest calculation, the interest rate will be considered as 0.708%, i.e. 8.5%/12.