Budget 2020: Here's how taxation on Provident Fund will change

A look at the important direct tax provisions introduced in Budget 2020.

Budget 2020: Here's how taxation on Provident Fund will change

Direct tax proposals in the recent Union Budget were minimal and targeted at benefiting the middle-class taxpayer. The avowed goals of these tax provisions are to stimulate growth, simplify the tax structure, bring about ease of compliance, and reduce litigation.

A simplified tax regime

A new and simplified tax regime has been proposed wherein the taxpayer can apply for lower rates of income tax in return for giving up claims on deductions and exemptions. Around 70 of the 100 or so existing exemptions and deductions are to be removed in the new simplified system. The remaining ones will be reviewed and rationalised in the coming years. 

This new tax regime is optional; an individual may continue to pay tax as per the old system and avail of existing deductions and exemptions. Those opting for the new regime will get the benefit of pre-filled income tax returns. It is estimated that the new regime will cost the government revenue to the tune of Rs 40,000 crore per year.

Taxable Income slab Existing tax rates New tax rates in force
INR 0-2.5 Lakh Exempt Exempt
INR 2.5-5 Lakh 5% 5%
INR 5-7.5 Lakh 20% 10%
INR 7.5-10 Lakh 20% 15%
INR 10-12.5 Lakh 30% 20%
INR 12.5-15 Lakh 30% 25%
Above INR 15 Lakh 30% 30%

Related: How to withdraw your PF online

Impact on PF contributions

Budget 2020 has thrown up another surprise and this one impacts the salaried individual. This is the cap set on tax-free employer contribution made to the employee’s superannuation account, which include the employee’s provident fund account, voluntary provident fund account, and national pension schemes. 

The cap set for the contribution that is not taxable is Rs 7,50,000. All contributions over and above this will be taxable. This comes as a surprise as the earlier rule did not lay down any monetary upper limit on these contributions. The earlier limit was a percentage – any employer contribution exceeding 12% of the employee’s salary would be taxable in the hands of the employee. 

This makes a big difference while calculating the tax payable.

  • For instance, for an individual whose monthly salary Rs 3 lakh, he will contribute 12% PF contribution which will come to Rs 4.32 lakh for the year.
  • If he has also opted for employer contribution to NPS, then 10% of basic totalling to Rs 3.6 lakh will be deployed in NPS.
  • His aggregate contribution will come to Rs 7.92 lakh. (Rs 4.32 lakh + Rs 3.6 lakh) 
  • Under the proposed law, Rs. 42,000 will be taxable. (Rs 7.92 lakh - Rs. 7.5 lakh) 

Another point has been laid down. This states that the interest, dividend, or any other amount accruing due to the additional contribution given by the employer will also be treated as a perquisite received by the employee from the employer and be taxable. 

Related: Government proposes key changes in Employees' Provident Fund (EPF) 

The rationale

The explanation given for this new rule was the principle of parity. The contention raised was that this rule of there being no combined upper limit to the contributions to approved superannuation funds was giving an undue benefit to high-salaried individuals who were structuring their pay packages in a way to receive maximum benefit from the taxability provisions of the superannuation and pension schemes. 

Finance Minister Nirmala Sitharaman stated this provision to be iniquitous to the lesser salaried and lower-income taxpayers, as they could not afford to give a larger portion of their income to these superannuation and pension schemes. In her opinion, the exempt-exempt-exempt (EEE) status of the provident fund and superannuation fund schemes were being cleverly used to obtain tax benefits for the higher-earning employees.

The amendment will take effect from 1st April 2021. Therefore, it will apply for tax returns from assessment year 2021-22 and thereafter. Employees to pay 20% TDS if they don’t provide PAN, Aadhaar detail. Read more about it here. 

 

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