Interest on PF contribution above Rs 2.5 lakh to be taxable (2024)

What the two tax blows given by Budget 2021 mean for you

The budget has taken away some of the tax-free havens widely used by high-income earners and HNIs. The interest earned by the Provident Fund contributions above Rs 2.5 lakh a year will now be added to the taxable income and taxed at the normal rates. This will only apply to the employee’s contribution and not that of the employer.

Last year’s budget had capped the tax exemption on employers’ contribution to Provident Fund, NPS and superannuation fund to Rs 7.5 lakh. While that impacted only employees with very high salaries, this year’s proposal has a wider impact. “This is a big change. It will hit high-income salaried people who use the Voluntary Provident Fund to earn tax-free interest,” says Amit Maheshwari, Partner and India Tax Leader, Ashok Maheshwary & Associates LLP.

Addressing a press conference after the Budget, Finance Ministry officials said that this new measure will impact less than 1% of the total subscribers to the Provident Fund.

This isn't the first time that the government has proposed to tax PF money. The 2016 Budget had proposed that the interest accrued on 60% of the EPF be taxed. The proposal was rolled back after a massive outcry against the new levy.

However, the proposal may not face as big a backlash this time because it affects only the creamy layer of salaried employees. The Rs 2.5 lakh annual threshold means that a person contributing up to Rs 20,833 a month to PF (basic salary of up to Rs 1.73 lakh a month) will escape the tax.

At the same time, the new Wage Code which comes into effect on 1 April has laid down that the basic salary must be at least 50% of the total income of the individual. This means the salary structure will have to be rejigged with a higher basic salary, which will automatically increase the contribution to the PF.

The budget plans to close down another tax-free haven for HNIs. Existing rules say that under Section 10(10d), gains from an insurance policy are tax free if the cover is 10 times the annual premium. The budget has proposed to remove the tax exemption to Ulips with a premium of more than Rs 2.5 lakh a year.

Such Ulips will now be treated like equity mutual funds, with gains of over Rs 1 lakh taxed at 10%. It is important to note that this Rs 2.5 lakh ceiling is the aggregate premium for all policies held by a policyholder, which means one cannot get past the tax by investing in multiple policies of less than Rs 2.5 lakh.

This will not apply to existing Ulips, but only to new policies bought after the budget was announced. While most budget proposals usually come into effect from the next financial year (1 April), this comes into effect immediately, thus closing the window for buying Ulips before the end of the financial year.

Insurance companies are miffed by the proposal but most are keeping mum. "The government has announced an increase in FDI for insurance sector from 49% to 74%, which is a positive move. But the taxation change for ULIPs would have an impact on such investments. The tax reduces the competitive advantage that ULIPs enjoyed as compared to other investment vehicles," said Tarun Chugh, MD & CEO, Bajaj Allianz Life Insurance.

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