Nirmala Sitharaman announced in Budget 2021 that interest received on EP contributions exceeding Rs 2.5 lakh will be taxable beginning 1 April. If there is no employer contribution, the deposit threshold limit in provident funds has been raised to Rs 5 lakh per year, with interest remaining tax-free. The government suggested a contribution threshold limit of Rs 2.5 lakh for tax exemption, with the goal of excluding HNIs from the benefit of high tax-free interest income on their large contributions. However, it has now been increased to Rs 5 lakh.
Employees of firms that are registered under the EPF Act are the only ones who can invest in the EPF or PF. Every month, the employee and the company both contribute 12% of the employee's basic salary and dearness allowance to the EPF account, with the company's contribution being different. Employee contributions to the EPF and interest* are tax-free. Section 80C allows for a tax deduction up to a limit of 1.5 lakhs.
If an employee receives interest on a contribution to the EPF or similar funds of more than Rs 5 lakh per year, he or she will have to pay tax if the employer does not contribute.
How increased EPF Tax-free income limit will affect your income?
A minimum of 12% of an employee's basic salary and performance wages will be deducted as provident fund contributions, with the employer contributing another 12%. Anyone contributing to earning more than Rs 5 lakh per year will have his or her EPF contribution interest taxed.
If an individual contributes Rs 12 lakh in a year, interest income till Rs 5 lakh will be tax-free and the remaining Rs 7 lakh is taxed. While the interest income of Rs 7 lakh would be Rs 59,500 at the 8.5 % EPF interest rate, at a marginal tax rate of 30%, the tax owed would be Rs 18,450.
If an individual's monthly contribution to the employees' provident fund is up to Rs 41,000 the interest income will be tax-free. If the contribution amount is greater than that, the interest earned on the extra contribution will be taxed. Individuals with a monthly basic salary of over Rs 3,00,000 will be affected by the move because their annual EPF contributions at a rate of 12% of basic salary will now surpass Rs 5 lakh. Please remember that this is the basic salary. When all the other factors are taken into account, the monthly salary will be much higher than the basic salary.
Employees who earn a high salary or make significant voluntary employee provident fund contributions may be affected by the existing tax rules.