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New EPF Tax Rules 2021: How Will It Impact You?

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As salaried individuals, many of you must have heard or seen the term Employee Provident Fund in your salary slips.

In fact, when you apply for a job and get selected, the HRs must have discussed the PF deductions during the salary discussion round.

Right?

Although the Employee Provident Fund stands as one of the basic benefits provided to the working individuals in a corporate set-up (employing at least 20 members), many people lack proper knowledge about the taxation rules in the interest and the changes that occur in that tax rules.

For instance, in the recently announced Union Budget of 2021, the Finance Minister proposed a limit on the provident fund contribution that is exempted from taxation. It will come into effect from April 1 2021.

Did you know about this?

Did you have any difficulties understanding the changes in the EPF tax rules announced by the government?

Not to worry, the following article is a complete guide to the Employee Provident Fund and the new EPF tax rules of 2021

So hop on with your reading glasses!

Employee Provident Fund: Meaning, Explanation & Advantages

The Employee Provident Fund scheme is a part of the Provident Funds and Miscellaneous Provisions Act of 1952. The working of this scheme falls under the vigilance of the Employees Provident Fund Organisation (EPFO). 

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But, what does this scheme state?

In simple terms, an employee needs to contribute some percentage of his/her salary as Provident Fund and an equal percentage of the money is contributed by the employer.

But, things are not as simple.

Yes, there are certain ifs and buts in the form of rules. The main rules outlined by this scheme are:

Rule For The Employer

The organizations operating with an employee size of 20 or more are obliged to follow this scheme. If any organization employs less than 20 people or a majority part of the employees says no to the EPF scheme, it can choose to opt-out. However, there are a set of formalities that have to be completed for the same.

Rule For The Employee

At the time of joining an organization, the employees having a salary of more than Rs. 15,000 per month can choose to opt for the EPF schemes. They can surely be a part of the scheme if the employer agrees. On the other hand, for employees who take home a salary less than Rs 15,000 per month, the EPF scheme is mandatory for them.

Also, all the employees have to decide whether they want to become a part of the EPF scheme (usually when they begin with their first job) or not because once they become a part of it, they cannot opt-out of it. And, this applied to the employees who have a salary of more than Rs 15,000 as it is compulsory for the ones earning less than this amount to become a part of the EPF scheme.

Now that I have told you about the basics of the Provident Fund, it is now time to move to the working of the same.

Advantages Of EPF

So, why should you choose to become a part of the EPF scheme when you get the deducted salary in-hand?

Find the answer yourself by going through the advantages that come with it!

  • The contributions made by the employees towards the EPF account is tax exempted due to the application of Section 80C. Not only this, until 31st March 2021, the interest earned from it is also free of income tax.
  • If you remain associated with the scheme for 5 years continuously then after 5 years, the withdrawal is exempted from taxation of any kind.
  • Any employee registering for an EPF account becomes eligible for the Employees Deposit Linked Insurance Scheme, which is a type of insurance cover.

Under this scheme, the nominee (registered by the employee) is entitled to get a lump-sum payment if the person taking the insurance cover dies.

How Does EPF Work?

The working of provident funds is not complex, it is just a process that takes place every month when your salary gets credited to your accounts.

But, there are certain rules of the Employee Provident Fund scheme whose compliance must be kept in mind by both the employer and the employee.

Let us begin with a detailed understanding of how EPF works!

Contribution of the Employee

To begin with, the contribution made by the employee of an organization is 12% of the basic salary that is credited to him/her.

For instance, if your monthly salary is Rs 25,000 then 12% of this amount would be Rs 3,000. Therefore, the EPF deduction will be Rs 3,000.

Contribution of the Employer

If the employee is contributing 12% of the basic salary, why should the employer fall behind!

Right?

Therefore, the employer also makes a contribution of 12% of the salary of the concerned employee towards the EPF account. On the other hand, if any organization has less than 20 employees, (if they opt for the EPF scheme), both the employer and the employee are required to pay 10% of the basic salary.

What Percentage of Money Goes Towards EPF?

One of the most important points you should be aware of is that an employee’s share of money does not completely get directed towards the PF account.

Out of the 12% which the employee pays, a total of 8.33% is directed towards the Employees Pension Scheme (EPS) and the remaining 3.67% goes towards EPF. But, this 8.33% is calculated on the employee’s salary. The EPS is meant for the aiding pension to the employees working in an organized sector and it is also regulated by EPFO.

For example, if you are earning a salary of Rs 25,000 then Rs 2,083 (8.33% of Rs 25,000) will be directed towards the Employee Pension Scheme.

Please note a very important point that, if the employees remain associated with EPS continuously for 10 years, then they will receive a lifelong pension after retirement.

Higher Contribution Made by the Employee Voluntarily

There might be situations where an employee would want to contribute more (above the set rate of 12% of the salary) towards the EPF for saving purposes. In this case, the employee is allowed to proceed with a high contribution and it is technically termed as a Voluntary Provident Fund.

Interest Rate and Tax Applied on Return

The interest rate on EPF is revised every year after a discussion between the Finance Ministry and the Central Board of Trustees of EPFO. If we talk about the interest rate for the fiscal year 2019-20, the interest rate applied on EPF was reduced to 8.50%. You can know the interest rate applied on EPF for the last five fiscal years through the table given below.

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Now, let us address the elephant in the room which the tax imposed on the EPF.  Until now (i.e. till 31 March 2021) no tax was applied to the return incurred by the EPF money. But, the rules have been amended and I will be discussing that in the following part.

How Can You Withdraw Money from an EPF Account?

The EPF Act says that an employee can claim the EPF money upon retirement after 55 years of age. Also, the EPF account will have all the contributions made by the employee, all its employers and the interest incurred on the money.

But, the employees are also provided with another option where they can withdraw 75% of their EPF money if they are unemployed for 1 month and the rest 25% when they have no job for 60 days and more.

You can read more about the withdrawal process through this detailed article provided by Economic Times.

The Benefit of Being Associated With the Scheme for 5 Years

When you start in your career, there is a general tendency of switching jobs initially. Well, if you have applied for the EPF scheme then make sure when you switch your job (be it after a year or two) you also get your EPF balance to the new employer. This is because, if you remain part of the EPF scheme continuously for 5 years (including the transfers) then after 5 years the withdrawals will be taxed.

For instance, you start to work with company A and during that time you become part of the EPF scheme. After 2 years you decide to switch the job and move to company B. But, at the same time, you get your EPF balance transferred to the new employer. And, you work there for the next 3 years. So, in this case, after 5 years any of your withdrawals will be taxed as a reward for remaining associated with the scheme continuously for 5 years.

Therefore, remember to get your EPF balance transferred to the new employer whenever you switch a job.

The New PF Tax Rule 2021

In the Budget announcement of 2021, the Finance Minister proposed certain changes regarding EPF money through the Finance Bill of 2021.

Initially, it was proposed that if the interest on the employee’s contributions towards EPF exceeds the limit of Rs 2.5 lakh in a year, it will be taxed. The new rules were to be implemented from April 1 2021.

But, a few days back during a debate over the Finance Bill, the government finally announced the changed rule. Now, the limit of tax-free interest earned through employee’s contribution has been raised from Rs 2.5 lakh to Rs 5 lakh per annum. Therefore, from April 1 2021, if the interest on the employee’s contribution crosses the threshold of Rs 5 lakh (towards EPF) in a year, then it will be taxed.

The final draft of the Finance Bill was approved and passed after voice voting.

The expert from the financial world believes that with this step the government is trying to limit the high earning individuals from contributing more towards their PF account because the interest was tax-free earlier.

How Will it Impact You?

On a practical note, this new step taken by the central government would not affect those who do not belong to the category of high-income earners. The move is estimated to impact only 1% of the total PF contributors in the country.

Further, people who do not belong to the category of high-income earners but have opted for a Voluntary Provident Fund (i.e. they contribute more than 12% of their salary towards EPF) will also get impacted.

Conclusion

The high-income earners or people who opted for the Voluntary Provident Fund tried to contribute more towards their EPF accounts as the interest earned on it was tax-free and the scheme was backed by the government.

In my view, the high-income earners and the employees who opted for the Voluntary Provident Fund were at an advantage as compared to the others because the interest incurred on the EPF money was tax-free. With the latest move taken by the government, the playing field is levelled now!

Dear readers, please feel free to share your views on the new PF tax rule in the comment section below.

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author

Shivani