Sanjiv Chaudhary, Financial Chronical 6/2/2012
In India, employees’ provident fund (EPF) is a benefit scheme for salaried individuals for their old age after retirement. Under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (PF Act), employers are required to contribute 12 per cent of their salary towards provident fund (PF) as specified, with a matching contribution by the employees.
In case of employees not being ‘international workers (IW)’ (typically foreign employees coming to or Indian employees going out of India on work, subject to conditions), the employer is mandatorily required to contribute towards PF, if the total number of employees earning salary up to Rs 6,500 per month is 20 or more in the establishment. However, employees earning monthly salary more than Rs 6,500, can voluntarily choose to contribute towards PF. The tax treatment of such amount at the time of contribution into a recognised PF and early withdrawal has been discussed below. The tax implications for IWs has not been discussed.
Salary for the purpose of PF: Salary for the purpose of PF would include basic wages, dearness allowance (including cash value of any food concession) and retaining allowance.
Basic wages means all emoluments which are earned by an employee while on duty /leave / holidays, according to the terms of employment and which are paid or payable in cash. This does not include house-rent allowance, bonus, commission, overtime allowance or any other similar allowance.
PF contribution by the employer: If the employer’s contribution to PF is up to 12 per cent of the salary, then the same is exempt from tax as per the income tax laws. A portion of the employer’s contribution is necessarily to be contributed by the employer into the pension scheme which is restricted to 8.33 per cent of Rs 6,500 per month (that is, Rs 541).
PF contribution by the employee: An employee can claim a deduction from salary up to a maximum of Rs 1,00,000 per annum under Section 80C of the Income-tax Act, 1961, on his contribution towards PF from his taxable income.
It should be noted that the contribution of the employee shall be equal to the contribution payable by the employer. However, the employee may at his option contribute an amount exceeding 12 per cent, subject to the condition that the employer shall not be under an obligation to contribute over and above his contribution payable under the PF act.
Interest on PF contribution: The employee earns interest on the PF amount that is contributed, both by him and his employer. Such interest is exempt from tax.
Transfer of PF: In case of change in employment, the employee is required to transfer his PF balance under the new employer’s account. Such a transfer does not entail any tax implications on the employee.
Withdrawal of PF: A member of the PF scheme shall be entitled to withdraw the PF amount standing to his credit on retirement from service after attainment of 58 years; retirement on account of permanent and total incapacity for work due to bodily or mental infirmity; termination of service in the case of mass or individual retrenchment; after two months of resignation in case of no employment. Under any of the above circumstances, the employee is not taxed on the PF withdrawal.
Taxability in case of premature withdrawal: In case the employee has rendered less than five years of continuous service, the employer’s contribution and interest, thereon, would be fully taxable as ‘salary income’ in the hands of the individual. Further, the employee’s contribution would be taxable to the extent of deduction claimed under Section 80C, if any, under the Income-tax Act,1961 and the interest earned on employee’s total contributions would be taxable as ‘income from other sources’ in the hands of the employee.
In short, PF can be considered as a tax planning measure in addition to being an avenue to provide safety and stability to the employee as well as his family.
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