Tax on accrued interest on EPF accounts

Taxation
1

I really want to start this post by saying “WTF Tax on accrued interest on EPF also”… but here is the explanations.

For Employee who is putting more than 2.5L of his contribution in EPF account will be taxed on accrued interest is what i understand from below link and passbook from EPFO website

Questions:

  1. How would one calculate accrued interest tax, if accrued interest is itself N.A on the passbook statement?
  2. Does anyone know the actual section, rule etc for this? except that it was introduced in Union budget 2021?

P.S: No CA from any metro city seems to know about this… either they or I am confused with the wordings…(me being no tax expert i think the later is more applicable)

2

Yes, I think awareness is still low and not many people know it. Besides actual interest payment by EPF happens really late, so there is no way to have actual details of taxable interest available when filing ITR.

I started calculating and adding this in my ITR last year. I am not a CA, but I can share publicly available information which I used for doing calculations

EPS passbook does show what is taxable contribution, though it does not show actual interest on that. I use taxable contribution and declared interest rate to calculate taxable interest.

I got this from below article by cleartax
A Complete Guide on Taxation of Interest on EPF Contribution Exceeding Rs 2.5 lakh (cleartax.in)

Look at illustration at the end

There is also an EPFO circular which has similar illustration, so I assumed it to be correct way to do it :slight_smile:
Check page 8
WSU_IT_PF_TDS_4581.pdf (epfindia.gov.in)

Relevant section of Income Tax act are section 10(11) and 10(12)
This is verbatim:
image

According to my situation, I report this income under head " Interest accrued on contributions to provident fund to the extent taxable as per first proviso to section 10(11)" in Income from other sources.

Hope this helps

3

Thank’s Few more questions,

  1. what is it about maintaining 2 different accounts from EPFO, where is this happening?(Or is this the new column that they added)
  2. I got the impression that contributions >2.5L are taxable at the rate for the given financial year., but what about next financial year do we have to carry forward the contributions(not the interest accrued) and add it to whatever amount >2.5L for that year and calculate taxes on it?
    Eg:
    Year Non-Tax Contributions. Taxable Contributions
    Year 1. 2.5L 1L
    Current Year. 2.5L. 1L

So the calculation for current year is
1L+1L* (Applicable EPF Interest) * (Applicable tax bracket)
or
1L * (Applicable EPF Interest) * (Applicable tax bracket)

4

That is for EPFO. In effect yes the new column they have in passbook, segregating non-taxable and taxable.

Yes, Taxable account is being maitained separately so for new year whatever is the balance that will earn interest. So in effect things get carried forward

Effectively this, but remember for next year 1L will not earn interest for whole year, so interest calculation would be 1L*interest rate + 1L * period * interest rate.
At least that is how I do it.

5

Is that because you have a PF setup by the central-govt ?

Reference: 10(11) and 10(12) in Section 10 of the IT-Act.

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If yes, in the ITR Schedule OS Interest section,

v. Interest accrued on contributions to provident fund to
the extent taxable as per first proviso to section 10(11)

To be filled by Central Govt. employees, with employer contribution to PF ?

vi. Interest accrued on contributions to provident fund to
the extent taxable as per second proviso to section 10(11)

To be filled by Central Govt. employees, without employer contribution to PF ?

vii. Interest accrued on contributions to provident fund to
the extent taxable as per first proviso to section 10(12)

To be filled by all other employees, with employer contribution to PF ?

viii. Interest accrued on contributions to provident fund to
the extent taxable as per second proviso to section 10(12)

To be filled by all other employees, without employer contribution to PF ?

1 Like
6

yeah, looks like I have messed up. I should be using 10(12). Mine is not a central govt PF.
Somehow I was told that 10(11) is for govt pf, and 10(12) for pvt trust
Never went into actual verbiage.
Based on exact wording, looks like I should be using 10(12)

yup, your classification looks correct to me. But again, I am not a CA :slight_smile:

7

That is horrible tax burden if i understand this correctly, every year if you exceed 2.5L then we have add them together for upcoming year calculate interest and pay its like interest compounding?

Eg:

  1. Year 1 contribution 5L in total, tax paid on 2.5L interest, 2.5L (carry forward)
  2. Year 2 contribution 5L in total, (current 2.5L + previous 2.5L) tax paid on interest of both, 5L(carry forward)
  3. Year 3 contribution 5L in total, (current 2.5L + previous 2.5L+previous 2.5L) tax paid on interest of all three, 7.5L(carry forward)
8

yes, it is horrible. And nothing we can do about it :frowning:
In fact, the way I understand it, interest earned on taxable part also gets added to taxable portion.

So in your example for year 2 5L in total + interest earned on it (around 40K) gets carried forward.

9

Eh… :person_shrugging:

Based on how EPF contributions are typically structured,
i.e. 12% of Basic-Salary, which itself is often a fraction of one’s complete salary,

If one is able to contribute >2.5L to their EPF in a year.
trying to save a few thousand rupees (this tax burden), would be the least of their worries.
Their time/focus would likely be better spent prudently managing the crores they would have earned in a few years.

10

I have different opinion here, my examples are ludicrous but this is like compounding tax which is something that will not leave you ever, it grows exponentially. year 10 its like SIP

The other side is even if you are Ambani or a middle class guy Money’s value is the same to both of them, just because someone has it more doesnt mean they will not feel the pinch… again exponential growth rate is wht i am afraid of…

11

A question still remains, what happens if you loose your job in between, since the carry forward still continues to earn interest… but no contribution so liable to pay tax or No?

12

What?? :laughing:
I thought it was obvious that the value of money drops the more one has.

Yes, the first million is super impactful on one’s life.
The 10th or the 100th million, not so much as the first million.

Coming back to realistic numbers,
what one needs to remember is that one is NOT paying income-tax on EPF contributions themselves.

Rather, one pays tax on the interest (~8% right now)
earned on any EPF contributions exceeding 2.5L in a year.

A simple way to think of this would be

  • EPF provides returns of X% on contributions upto 2.5L (actually 5L as a matching 2.5L by the employer)
  • EPF provides returns of Y% on an subsequent additional contributions in the year
    • continues to provide X% returns on the first 2.5L / 5L contributed each year.
    • where Y is around 0.6 * X for most folks.

Note that the contributions were already earning compounding interest.

Yes.
However, the above scenario without a job / any significant income
one will fall within the zero-tax slab.

Alternately, if one has some other significant surce of income and is in a taxable bracket despite losing one’s job and paying no EPF in the year, then the impact of a few hundred rupees on tax on the accumulated taxable interest over the years is again minimal on one’s finances.

13

It is a horrible tax because of the following 2 reasons:

a) This is a forced investment. Employees do not have a choice of not contributing above 2.5 lakhs p.a. Levying tax at marginal rate at something which is forced on the employees is atrocious. When the government set this limit, they gave example of people putting in crores of money per annum in EPF account as a misuse but finally when the limit came, the limit was set at 2.5 lakhs which is too low for building a retirement corpus. If the government doesn’t want to offer tax free income, then it should give employees the option of not contributing above 2.5 lakhs to PF account.

b) Investment in EPF is supposed to be for retirement. With average pay, you will start breaching this limit of 2.5 lakhs EPF contribution when you are between 30-40 years of age with retirement approx. 25 years away. A post tax return of 5.4% on a 25 year locked in investment which is supposed to take care of your retirement is abysmal for a developing country with inflation at 4-6%. At best you are just preserving your investment and not growing it.

2 Likes
14

@PK123 Valid points.
However, i still see no issues with the way EPF is structured currently,
when seen within the overall context.

Here’s the additional context i have in mind -

1. Choice exists

The usual method to go about this is to talk to one’s employer and negotiate a lower basic-pay (of which PF contributions are 12% of). Generally employers will be happy to oblige as this reduces their matching contribution as well.

2. Not the average Joe here

IMHO, not even close.

Based on how EPF contributions are typically structured,
i.e. 12% of Basic-Salary, which itself is often a fraction of one’s complete salary,
to start breaching this limit, one would need to start in the top 10% (and reach top1%).

Remember that this is tax-free on redemption/withdrawal.

Also, remember that this will be the second risk-free return.
The first risk-free return (upto 2.5L contributed each year) providing entire tax-free investment at EPF rates.

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[Source]

3. Luxury comes at price.

(a.k.a. Free lunches? sure. But, no free gourmet dinners.)

Congratulations! You are achieving a level of financial maturity that is not common.
There are no free lunches.
There are no risk-free pensions to free-load on.
There are no inflation-beating returns to be had without taking risk.

EPF enables one with a sold foundation on which to survive on.

Thrive? Well right now one is free to pursue other endeavors
- with one’s time/life
- and the majority of the capital one earns,

adopting necessary risky propositions as per one’s risk-appetite

  • to fulfill any luxury one may have in mind right away
  • or amass additional capital over the long-term.

3. Risk-free* returns

*as close to zero risk

The biggest point to remember is that
what EPF provides is a risk-free rate of return
very similar to sovereign govt. bonds.

Note that even sovereign govt. bonds have been providing around 7-8% returns with the interest income being taxed (unlike EPF so far). So, in that sense, any contribution to EPF above 2.5L in a year is like (not exactly, but very similar to) being guided to purchase a sovereign govt bond and pay taxes on the interest.

One aspect where EPF excels GSECs is that - contrbutions to EPF are using pre-tax income.
One can purchase GSECs using what is leftover from one’s income AFTER paying taxes.

Someone who is bothered by the lower returns of EPF contribution above 2.5L
and is really interested to invest more of their capital into riskier ventures,
can simply reduce their govt. debt securities (GSECs, TBills) investment by the same amount.

Oh, but you are NOT into GSECs/TBills at all you say.
Then maybe consider reducing the next low-risk investments you have.

Purely from a risk perspective,
here’s a handy list i like to use personally.

A list of investments in increasing order of risk

(based on personal risk assessment)

  1. 80C
  2. PF
  3. FD
  4. GSECs
  5. Gold
  6. Indian Large-cap ETF
  7. Indian Mid-cap/Small-cap MF
  8. Equity via individual stocks
  9. Real estate
  10. P2P lending
  11. Other speculations

What’s your list?

Now that you know that there is tax on the interest on EPF contributions > 2.5L,
How do you plan to tweak you other investments to adjust for risk/returns? :slightly_smiling_face:

15

This is only possible in (most) private sector companies (not in public sector companies or government owned companies).

If it is luxury, why is it compulsory? Just give an option to all employees to not contribute beyond 2.5 lakhs. People who think it is a luxury will keep contributing and people who think of it as a punishment will stop contributing.

In the context of incremental investment over and above 2.5 lakhs (employee contribution to PF), the incremental investment is not pre-tax income. It is post tax income (since 80C allows deduction of only upto 1.5 lakhs under old tax regime, and there is no deduction for your contribution under new tax regime).

1 Like
16

Excellent points! :clap: :clap:

So, essentially,
this already acts as a nudge away
from public-sector companies or government-owned companies
that do not provide an option to reduce basic-salary (and hence the PF).

Add to this the long-pending imminent migration to the new-tax regime,
and EPF is soon going to be a worse version of GSECs (in all aspects).
(due to the forced-contribution, lack of any tax-incentives, and long lock-in) :

17

It is for average Joe

What table you show above is just 1/2 the truth you also have to show how expenses are distributed across Eg: A vegetable(cabbage) is ~7rs when you are in village and ~15rs in metro city, same for rent and other expenditure.

Lets take a case of a person in metro city with package of CTC 24L i would consider this person as average if not lower middle class. He too have to pay taxes on this!!! … they are small in beginning but later they add up… assuming he has 30Years to retire… following looks like as a calculation table

Basic 2100000
Variable 15%
Contibution 12%
EPFO ROI 8.15%
Tax 31%
Average Yearly Salary Increment 1%
Year Basic Variable CTC Employee Contribution Beyond 2.5L Contri Taxable Interest Tax(May vary)
1 2100000 315000 2415000 252000 2000 163 50.53
2 2121000 318150 2439150 254520 4520 544.6645 168.845995
3 2142210 321331.5 2463541.5 257065.2 7065.2 1164.868457 361.1092216
4 2163632.1 324544.815 2488176.915 259635.852 9635.852 2045.127174 633.9894239
5 2185268.421 327790.2632 2513058.684 262232.2105 12232.21052 3208.730196 994.7063608
6 2207121.105 331068.1658 2538189.271 264854.5326 14854.53263 4680.886116 1451.074696
7 2229192.316 334378.8474 2563571.164 267503.078 17503.07795 6488.879187 2011.552548
8 2251484.239 337722.6359 2589206.875 270178.1087 20178.10873 8662.238703 2685.293998
9 2273999.082 341099.8623 2615098.944 272879.8898 22879.88982 11232.92218 3482.205875
10 2296739.073 344510.8609 2641249.934 275608.6887 25608.68872 14235.51347 4413.009174
11 2319706.463 347955.9695 2667662.433 278364.7756 28364.7756 17707.43702 5489.305478
12 2342903.528 351435.5292 2694339.057 281148.4234 31148.42336 21689.18965 6723.64879
13 2366332.563 354949.8845 2721282.448 283959.9076 33959.90759 26224.59107 8129.623232
14 2389995.889 358499.3833 2748495.272 286799.5067 36799.50667 31361.05504 9721.927061
15 2413895.848 362084.3772 2775980.225 289667.5017 39667.50174 37149.88241 11516.46355
16 2438034.806 365705.2209 2803740.027 292564.1768 42564.17675 43646.57824 13530.43925
17 2462415.154 369362.2732 2831777.427 295489.8185 45489.81852 50911.19457 15782.47032
18 2487039.306 373055.8959 2860095.202 298444.7167 48444.71671 59008.70134 18292.69742
19 2511909.699 376786.4548 2888696.154 301429.1639 51429.16387 68009.38735 21082.91008
20 2537028.796 380554.3194 2917583.115 304443.4555 54443.45551 77989.29405 24176.68116
21 2562399.084 384359.8626 2946758.946 307487.8901 57487.89007 89030.68455 27599.51221
22 2588023.075 388203.4612 2976226.536 310562.769 60562.76897 101222.551 31378.99081
23 2613903.305 392085.4958 3005988.801 313668.3967 63668.39666 114661.1633 35544.96061
24 2640042.339 396006.3508 3036048.689 316805.0806 66805.08062 129450.6621 40129.70526
25 2666442.762 399966.4143 3066409.176 319973.1314 69973.13143 145703.7013 45168.1474
26 2693107.19 403966.0784 3097073.268 323172.8627 73172.86274 163542.1413 50698.06379
27 2720038.261 408005.7392 3128044.001 326404.5914 76404.59137 183097.8 56760.31799
28 2747238.644 412085.7966 3159324.441 329668.6373 79668.63729 204513.2646 63399.11203
29 2774711.03 416206.6546 3190917.685 332965.3237 82965.32366 227942.7696 70662.25856
30 2802458.141 420368.7211 3222826.862 336294.9769 86294.97689 253553.1459 78601.47523

Again i would say, paying taxes is not bad but having it recurse it definitely bad and its too much of burden now with genuine people who are paying taxes.

Also most Private MNC will deny your request to change your PF contribution…

1 Like
18

Hi @pyarlath we disagree on this assumption.

I consider a person earning 24L annually,
especially salaried-class,
in the top 10% of income. :slight_smile:

So, definitely NOT middle-class,
unless middle-class is defined as earning between 5% - 95% :sweat_smile:

This is my source.

What are your reasons
to consider such a person earning 24Lacs annually as middle-class? :thinking:

Am not quite sure that the extent of increased expenses in cities/metros can justify such high-income individuals to be classified as the middle-class.

1 Like
19

I see this post turned into “definition of middle class” rather than tax itself : ) , but just to close if you are in metro city take that 24L try to deduct expenses(rent, cost of living etc) (This is the other half of the data that needs to be considered with the income inequality data to come to any conclusion)

Back to the tax thing:

  1. I feel this tax itself is not justified…A instrument which was supposed to be tax free for salaried and best source for retirement being changed is not right.
  2. They don’t allow to change my contribution, even though it may be on paper is another issue.
  3. The carry forward balance and interest is also taxed is another stab at people…

If i had to suggest a change, I would allow the extra taxable balance to be with-drawable any time without any tax implication.

What i wanted to show in the above calculation is with time Tax increased by a CAGR of 27% but income 0.97%

20

Just another data-point, (your experience may vary from mine)
The “Basic salary” at these payscales is usually not >85% of CTC.
It is closer to 50% (than 85%).

Why is this relevant?
Because if one is earning in the top 10% (or 1%)
one should expect to be progressively taxed higher accordingly.
Not taxed favorably (or even similar) to relatively lower income earners.

Which is the freedom of choice.

  • Live a life of luxury (YOLO)
  • or save/invest to compound capital (FIRE),
  • or something in between (most folks).

i think it is perfectly justified.

My point still being that
the few thousands paid as a tax on interest
…earned on a small part of the PF
…which is a small part of basic
…which is a small part of one’s income
is a effectively a “rounding error” for someone who is earning in lacs/crores.

and is free to deploy the remaining capital over the years to compound into tens of crores.
(i.e. after few decades, even a lac saved in PF interest is a “rounding error” in the overall finances of such a person)

A well implemented progressive tax.
(can it be even better? sure. i see you have a few idea in the latest post above :slightly_smiling_face::+1: )

Also, if you are saying that
EPF from the 1990s is way better than this EPF in the 2020s,
then yes, in terms of risk-free returns, sure. :slight_smile:

Can you also share the following numbers?
(which i hope will help understand the overall context :slight_smile:)

Q1. What’s the CAGR on the income from EPF (both taxable-income and non-taxable income)?

Q2. In year 30,

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when the taxable-interest earned in the year is 2,5L,
and one is being asked to pay 78K as tax
what is the non-taxable-interest earned in the year?