Tax Breaks on PF and Gratuity

PF contribution of Rs 1 lakh, gratuity of Rs 10 lakh eligible for tax breaks

Saraswathi Kasturirangan, Economic Times 15/11/2011


Just as a bird builds up its nest, twig by twig, retirement benefits of employees are built up throughout the employment period.

However not many of us really know what benefits we are entitled to, when we are entitled to the benefits, how the accumulation happens, how much of this we receive back, etc. The most common of these are provident fund, pension and gratuity benefits.

Provident Fund: Also known as PF, it is a defined contribution plan, where the employee contributes 12% of the pay on a monthly basis; the employer is responsible for an equal contribution, out of which a part is remitted towards the pension fund.

The employee may opt for an additional voluntary contribution. However, the total employee contribution may not exceed 20% of the pay. The employee may also request the employer to limit the amount of "pay" for computations of PF to 6,500 per month. Such an option may be exercised only at the beginning of employment. The balance in the PF account earns a cumulative interest at government specified rates, currently at 9.50% per annum.

Employees are entitled to withdraw the balance on retirement at the age of 55. Early withdrawal is permissible in case of exigencies such as:

1) Retirement on account of permanent and total incapacity for work (suitable certification required)

2) Migration from the country

3) Retrenchment, etc

Employees are entitled to refundable/non-refundable loans for purchase/construction of house, education, marriage, treatment for specified illness for self/family members, etc, on meeting the specified conditions.

Tax implications on recognised provident funds: The employer contributions (12% of pay less contribution to pension of 542 pm) is not considered taxable. The employee contributions (12% of pay) are entitled for a deduction of up to 1 lakh while computing the taxable income (under Section 80C).

The interest on employer contributions at rates specified is not taxable to the extent the credit does not exceed government-specified rates (currently at 9.5% pa). The Interest on employee contributions is not taxable to the extent the credit does not exceed government-specified rates (currently at 9.5% pa). The withdrawal of the balance on retirement is not taxable if the employee has rendered continuous service of five years.

Employee Pension Scheme: It is a a defined benefit plan and is also known as EPS. A part of the employer contribution at 542 per month, being 8.33% of the pay, is remitted towards the pension scheme. The pay for this purpose is limited to 6,500 per month. The central government adds in a contribution of 1.16% to the pension fund of the employee. To be eligible for pension, contributions should be made for a minimum period of 10 years.

The monthly pension is available on retirement at the age of 58. Early pension is also possible from 50 years of age. The monthly pension for those who became members of the scheme after November 16, 1995 will be the pensionable salary multiplied by the pensionable service divided by 70.

For those who became members before November 16, 1995, the pension sum will be as above or 635 per month, whichever is higher plus the past service pension computed in a gradated manner as provided in the Act.

The total pension shall be subject to a minimum of 800 per month for eligible service of 24 years. The pensionable salary for calculating the pension will be the average of the last 12 months’ pay, limited to 6,500 per month unless a higher contribution has been made at the option of the employer and employee.

The above provisions are as applicable to domestic workers. The ministry of labour and employment has introduced the concept of international workers (IWs) effective from November 1, 2008.

Foreign citizens employed with an entity to which the provisions of PF Act applies as well as Indian outbounds to countries with which India has signed a social security agreement (SSA) would be considered as IWs. Withdrawal norms relating to IWs have recently been tightened and IWs may now withdraw the funds only on:

1) Retirement at the age of 58

2) Specified medical grounds subject to documentation.

Also, contributions to pension in the case of IWs would be at 8.33% of the pay.

The limit of 6,500 per month as indicated for domestic workers above is not applicable to IWs.

Gratuity: This is a defined benefit plan, funded by the employer. Such amounts may be considered as part of cost to the company (CTC) of the employee. Gratuity payments are governed by the Payment of Gratuity Act, which covers establishments having more than 10 employees.

The minimum period of employment to be eligible for gratuity is five Years. (This is not applicable in the case of death or disablement). The benefit on superannuation, retirement, resignation will be calculated as follows: (monthly pay X 15 X no of years of service)/26. (Here, the monthly pay refers to the last drawn pay.) Effective from May 24, 2010, the applicable ceiling on gratuity is 10 lakh.

Tax exemptions are available for amount not exceeding 10 lakh. The amount is fully exempt for central/state government employees; for employees covered under Payment of Gratuity Act, payment as specified in the Act is exempt; for other employees, gratuity computed in a specified manner is exempt.

Employers are permitted to have a scheme that is more favourable than the provisions of the Act.

Hence, they may provide for a higher benefit or have a lower period of service for employees to be eligible for gratuity.


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