A major part of a salaried individual’s savings is generally parked in retirement accounts such as provident fund, superannuation fund and National Pension Scheme (NPS). These investments provide dual tax advantage — exemption/deduction in the year of contribution up to specified limits, and exemption at withdrawal, of amounts including accretions, if required conditions are met.
Under current provisions of the Act, the contribution by the employer to the account of an employee in a recognised provident fund, exceeding 12 per cent of salary, is taxable. Further, the amount of any contribution to an approved superannuation fund by the employer, exceeding Rs 1,50,000, is treated as perquisite in the hands of the employee.
Similarly, the assessee is allowed a deduction under NPS for 10 per cent of the salary contributed by his employer. Prior to April 1, 2020, there was no combined upper limit for the purpose of deduction on the amount of contribution made by the employer.
It was observed by the government that employees earning high salary incomes would restructure their salary package in such a manner that a large part of their salary would be contributed into one or more of these three funds as they were exempt and earned a decent return. To prevent such practices, an upper limit was introduced to restrict tax benefits to high salaried employees.
The Finance Act, 2020 introduced a combined upper limit of Rs 7,50,000 in respect of an employer’s contribution in a year, to NPS, superannuation fund and recognised provident fund. Thus, effective from April 1, 2020, any contribution exceeding this limit is taxable as a perquisite. In addition, the annual accretion by way of interest, dividend or similar income on such excess contribution is also taxable as a perquisite. This was the first step in moving away from the EEE (exempt-exempt-exempt, i.e. exempt at the time of contribution, accretion and withdrawal) regime of taxation. The manner in which the perquisite value has to be computed was also prescribed in March 2021.
However, there are other challenges in computing the perquisite value. There is no clarity, for instance, on how the excess contribution is to be apportioned between PF, NPS and superannuation, as different apportionment methods are possible. Another question that may arise is whether any accretion on NPS investments should be considered for perquisite valuation.
Further, to rationalise tax exemption for the income earned by such high-income employees, Finance Act 2021 introduced taxation of interest accrued on employee contribution to PF above a threshold. Effective from April 1, 2021, the interest accruing on employee contributions to PF in excess of Rs 2,50,000 in aggregate, during a year, is taxable. Increased limit of Rs 5,00,000 applies in a situation where there is no employer contribution. Under erstwhile provisions, the same was exempt, provided the specified conditions were met.
The investment in NPS comes with limitations on withdrawal. NPS may provide higher returns than PPF or FDs, as this is more market-linked. Further, with the increase in the age limit for joining NPS from 65 years to 70 years, and with the extension of the exit age limit to 75 years, one can enjoy an additional tax benefit of Rs 50,000 on investment in NPS (Tier I) each year, under Section 80 CCD(1B).
The taxation of employer contribution and of interest accrual on employee contribution, in excess of specified limits, would impact high salary earning individuals, as the contributions along with accretions, which were earlier exempt on withdrawal, are now subject to tax. The question that arises is on the tax treatment of this portion, in the year of withdrawal — would it be taxed again? Going by principles of tax laws, as the same income cannot be taxed twice, hence it may be possible to argue and defend that this portion is not taxable in the year of withdrawal.
Gratuity, another retirement fund, also enjoys a tax benefit of up to Rs 20 lakh. Individuals receiving monetary benefit at the time of retirement, resignation or death would get benefitted.
While the above is from the taxation perspective, it is critical to understand the impact of the new labour codes on retirement benefits.
As part of labour law reforms, the Government of India has undertaken rationalisation of 29 labour regulations and subsumed them into four labour codes. All four codes have received presidential assent and are expected to become effective within this financial year.
While employers are in the process of analysing the impact — financial, operational and legal — there is also anxiety among employees on the uncertainty surrounding their wages, their take-home pay and retirals, etc.
The labour codes include provisions relating to employee benefits such as PF, gratuity, etc, potentially impacting employee benefits as well as take home pay. Also, there are provisions for the new category of workers such as gig workers, platform workers, self-employed etc., to ensure their coverage under the social security regime.
With the widening of the definition of “wages” under the codes, there would be an impact both on employers and employees. For employees drawing wages less than Rs 15,000, employer and employee PF contributions would increase, thereby reducing the net pay of employees and increasing the employer’s cost, in cases where PF is above the cost- to-company (CTC). There could be a likely impact on higher income employees as well, if company policies provide for contributions to be based on the definition of wages as per the codes.
Under the codes, gratuity is required to be paid out on the last drawn wages, as against the basic pay plus dearness allowance, which is currently provided. This would mean that employees are entitled to gratuity based on the new definition of “wages”, even for their past service period. Many employers carve out gratuity as part of the agreed total compensation. Higher gratuity contribution could therefore also mean that there is an impact on the take home pay of employees, going forward. Several representations have been made to the government to minimise this impact.
While these new laws have been enacted and the rules, which are evolving, are still in the draft mode, representations have been made and clarity is awaited on whether salary components such as one-time payouts, variable pay, benefits in kind, etc., can be included in the definition of wages. The impact would be dependent on the final outcome of these deliberations and representations.
With all these changes, retirement funds, which are our savings for the post-employment period, have been impacted. Accordingly, long-term financial planning has to factor in the impact of all these changes to ensure financial protection.
The author is Partner, Deloitte India
[With inputs from Poornima G, Senior Manager, and Nidhi Agarwal, Deputy Manager, Deloitte Haskins and Sells LLP]