Summary of this article
The Employee Provident Fund is widely seen as fully tax-free, but its EEE status has important limits.
Under the old regime, employee contributions up to Rs 1.5 lakh get a deduction, but none is allowed in the new regime.
Employer contributions also become taxable under certain conditions.
The employee provident fund (EPF) has been the sole instrument for employees in private companies for decades. The instrument gave two-way benefits, one, through a kind of forced saving, and two, the tax benefits offered on deposit, interest, and withdrawal. Although EPF has the reputation of an exempt-exempt-exempt (EEE) taxation instrument, it is not completely true. Under certain conditions, it attracts tax.
EPF is a social security product for those employed by an organisation. As per the rule, an organisation employing 20 or more employees is mandated to register itself with the Employees’ Provident Fund Organisation (EPFO). It is a mandatory contribution for employees earning up to a Rs 15,000 salary. Both employee and employer contribute 12 per cent of the salary per month to the EPF account of the employee. However, employees may voluntarily contribute a higher amount under a voluntary provident fund (VPF), under which only they contribute the higher amount, not the employer.
As tax benefits are available at three stages – contribution, interest, and withdrawal, let’s see at which stage EPF can become taxable.
On Contribution:
Under the old regime, employee contribution (up to Rs 1.5 lakh) under Section 80C is eligible for deduction. No such deduction on employee contribution is available under the new tax regime.
On the other hand, employer contribution (up to 12 per cent of basic salary) per annum is eligible for tax exemption. Beyond this, it becomes taxable.
Anurag Jain, Partner, ByTheBook Consulting LLP, Gurgaon, clarifies, “The employer's contribution becomes taxable if the combined yearly employer contribution to EPF, National Pension System (NPS), and superannuation exceeds Rs 7.5 lakh. This applies under both the old and new tax regimes.”
On Interest:
The tax benefit on contribution is available only up to Rs 1.5 lakh, but as employees are allowed to contribute voluntarily in EPF, if their contribution exceeds Rs 2.5 lakh in a year, interest on the exceeding contribution becomes taxable.
“If employees' own PF contribution exceeds Rs 2.5 lakh in a financial year, the interest earned on the excess amount becomes taxable”, says Jain.
Simply put, interest on employee contribution of up to Rs 2.5 lakh in a year is tax-free, while interest on employer contribution also remains tax-free.
Jain explains, “While employer contributions and interest earned remain tax-exempt under the new tax regime, employee contributions are no longer deductible. So the first "E", the upfront tax deduction under Section 123 of the Income-tax Act, is gone if you are in the new regime. The interest and withdrawal exemptions largely survive, subject to conditions.”
On Withdrawal:
EPF withdrawals are fully tax-exempt if funds are withdrawn after completing five years of continuous service. This continuous service could be with one employer or many employers.
Jain says, “Withdrawals made before completing five years of continuous service are taxable under the Income-tax Act, except when they qualify for specific exemptions, such as termination due to ill health, employer closure, or circumstances beyond the employee's control.”
EPF withdrawal from an employer’s EPF Trust that is not recognised by the Income-tax Commissioner is also taxable. Further, the interest earned after cessation of employment (even after satisfying a 5-year continuous service period) is also treated as taxable income in the hands of the individual, says Jain.
So, if you plan to contribute more to EPF or withdraw the fund for some reason, check the taxation part as well, or the social security scheme will end up being simply a parking instrument with no actual savings.
