Tax on PF Withdrawal

PF Withdrawal

Employee Provident Fund(EPF) scheme was set up to give substantial benefit to the employee at the time of retirement. Under the scheme a specified sum is deducted  from the salary of the employee as his contributions towards the fund. The employer also contributes the same amount. Under the provisions of Income tax laws, withdrawal from the PF account by an employee without rendering continuous service for five years or more to the employer attracts tax. It is be taxable in the hands of the individual as if the fund was not recognised from the start of the contributions This article talks about different kinds of Provident Funds (Recognised, Unrecognised), Overview of EPF or Recognised Provident Fund, when is withdrawal exempt from tax, Tax on withdrawal before 5 years, TDS on withdrawal amount, Relief under Section 89. Our articles Basics of Employee Provident Fund: EPF, EPS, EDLIS, Withdrawal or Transfer of Employee Provident Fund cover how to withdraw, transfer EPF account.

Kind of Provident Funds

When the Employee Provident Fund amount is withdrawn before five years of continuous service, it is be taxable in the hands of the individual as if the fund was not recognised from the start of the contributions i.e Provident Fund would be treated as an Unrecognised Fund from the beginning. Let’s understand different kinds of Provident Funds. Provident Fund is a retirement benefit scheme and are of following types:

  • Statutory Provident Fund: refers to the Provident Fund formed under the Provident Fund Act, 1925. This fund is maintained by Government and Semi Government organisations, local authorities, railways, universities and recognised educational institutions.
  • Recognised Provident Fund (RPF) – A Provident Fund to which Employee’s Provident Fund and Miscellaneous Provisions Act 1952 applies is a recognised Provident Fund. This type of provident fund is applicable to an organization with strength of 20 or more employees(organisations with less than 20 employees can also join). A Recognized provident fund is  approved by the Commissioner of Income Tax. An employer and a group of employees can start this type of recognized provident fund together by forming a trust. According to Section 80-C upto 12% of salary is exempted from the tax. Interest rate of 9.5% is added to the salary. Nothing will be taxable if the employee left the job after five years of completion of service or an employee left the job due to terminal illness. If the business is shut down, the employee is not subjected to tax. When we talk of Employee Provident Fund we usually mean Recognised Provident Fund.
  • Unrecognised Provident Fund (URPF)  This type of provident fund is not recognized by the commissioner of income tax.  There will be no deduction under section 80-C available. Any amount of contribution is not taxable. Here, the employer’s contribution is taxable as salary income. Employees own contribution is non-taxable.
  • Public Provident Fund (PPF). It was established for the benefits of general public. Any member of public whether a salaried employee or a self employed person can participate. It is one of the best tax saving schemes in India

Following table highlights the exemption and deduction available in respect of contribution to and payment from various kinds of provident fund.

  Statutory provident fund Recognized provident fund Unrecognized provident fund Public Provident Fund
Employer’s contribution to provident fund Not taxable Not taxable up to 12 per cent*of salary Not taxable Employer does not contribute
Deduction under sec 80C Available Available Not available Available
Interest credited Fully exempt Exempt if rate of interest does not exceed notified rate of interest i.e 9.5% Exempt from tax Exempt from tax
Lump sum payment received at the time of retirement or termination of service or withdrawn Exempt u/s. 10(11) Exempt from tax u/s. 10(12) Subject to conditions: not taxable if employee retires after 5 years of service or due to inability of work. Otherwise treated as URPF Employee’s Contribution
exempt from taxInterest thereon is taxable under the head of income from other sources.Employer’ s contribution
and interest thereon is
taxable as Profits in lieu
of Salary, under” Salaries”)
Exempt from tax u/s 10(11)

Recognised Provident Fund

Employees drawing basic salary upto Rs 6500/- have to compulsory contribute to the Provident fund and employees drawing above Rs 6501/- have an option to become member of the Provident Fund. . Employee’s contribution is matched by Employer’s contribution(till 12%)so extra money. Contribution is divided between (pdfs )

1. Employees’ Provident Fund Scheme, (EPS)1952
2. Employees’ Deposit Linked Insurance Scheme,(EDILS) 1976
3. Employees’ Pension Scheme, 1995 (replacing the Employees’ Family Pension Scheme, 1971)(EPS)v

The most commonly used contribution break is as follows (There are other methods which you can check in Our article Basics of Employee Provident Fund: EPF, EPS, EDLIS):

PF contribution by the employer:  A portion of the employer’s contribution is necessarily 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). If the employer’s contribution to EPF is up to 12% of the salary, then the same is exempt from tax as per the income tax laws.

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 EPF from his taxable income.

Interest on PF contribution: The employee earns interest on the PF amount that is contributed, both by him and his employer. The accounting period of PF is from March to February every year.The government credits the interest compounded on PF balance in April every year. Such interest is exempt from tax.

Scheme Employee’s contribution of basic pay Employer’s contribution
EPF 12% 3.67%
EPS 8.33%

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,called as Voluntary Provident Fund (VPF), 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.

Let’s assume, an employee starts with a basic salary of Rs. 20,000. Every year, on an average, he gets a 5% increment. He contributes 12% of his basic salary towards PF which is matched equally by his company, EPF contribution is 3.67%, EPS contribution is 8.33%. EPF Interest is 8.5%.   Using  EPF Calculator : Method I 3.67% the break up of Employer, Employee Contribution and Interest is as follows:

Years Opening Balance Monthly basic (Rs.) Employee PF (Rs.) Employer PF (Rs.) Interest on Employee Part Interest on Employer Part Total EPF amount (Rs.)
1 0 20,000 28,800 8,808 2,448 748.68 40,804.68
2 40,804.68 21,000 30,240 9,248 2,570.4 786.08 87,117.992
3 87,117.992 22,050 31,752 10,196 2,698.92 866.66 1,98,605.064

Withdrawal from EPF exempt from tax

Rule 8 of Part A of the Fourth Schedule of I T Act provides the circumstances under which withdrawal by an employee is exempt from tax . If employee fulfills any of following conditions, payment from recognized provident fund is tax free :

  • 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
  • If the employee has rendered continuous service with the employer(s) for five years or more. If the balance includes amount transferred from the individual’s PF account maintained by previous employer(s), then the years of continuous service rendered to the former employer(s) would be included for the purpose of computing the five-year period.
  • If the employee has not rendered continuous service of five years, but the service is terminated by reason of the employee’s ill health or discontinuance of the employer’s business or reasons beyond the control of the employee, the amount will be tax-exempt.
  • Another tax-exempt case is when, on the cessation of the employment, the employee finds another job and the the accumulated PF balance is transferred to his individual PF account maintained by the new employer.

Taxability in case of withdrawal before 5 years

When the PF amount is withdrawn before five years of continuous service, it is be taxable in the hands of the individual as if the fund was not recognised from the start of the contributions.Provident Fund would be treated as an Unrecognised Fund from the beginning.

  • The employer’s contribution and interest, thereon, would be fully taxable as as profits in lieu of salary or ‘salary income’ in the hands of the individual.
  • 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.

To recap, The various heads of income for income tax purpose (covered in detail in our article  Income Tax overview) are :

  1. Salary
  2. Income from house property
  3. Profits and gains from business or profession
  4. Capital gains
  5. Income from other sources

In above example various contributions will be as follows

  • Employer’s contribution + interest = (8,808 + Interest on 8,808 for 3 year ) + (9,248 + interest on 9,248 for 2 year) + (10,196 + interest on 10,196 for 1 year) will come under Salary income
  • Employee’s contribution (Assuming he has claimed entire contribution in 80C) = 28,800 + 30,240 + 31,752  will be taxable.
  • Interest earned on his contribution (interest on 28,800 for 3 years+interest on 30,240 for 2 years + for 1 year on 31,752 ) as ‘income from other sources’

However, if the accumulated balance in PF account is transferred to recognized PF account maintained by the new employer, no tax liability shall arise due to such transfer. If you don’t withdraw/transfer from the PF and if there is no contribution in an individual account for a period of 36 months, then the interest will stop. Such EPF accounts are called dormant accounts. However, dormant accounts will continue to earn the interest for 36 months during which it remained dormant. Before this amendment(Apr 2011), interest was deposited in accounts regardless of whether there were any contributions coming in or not. Ref:DNA Is your EPF account dormant? Act now   Just holding the PF account with the employer for five years shall not take away the tax implications.If you intend to take job after some time(say after higher studies) you can leave your PF account and after joining transfer it to new employer.

Tax Deducted at Source (TDS) for EPF Withdrawal

The Income Tax Department has instructed EPFO (Employees Provident Fund Organisation) to deduct Tax (TDS) from the withdrawal amount, if the withdrawal happened before completing five years of subscription. TDS is deducted at the rate of your income slab(if you earn more than 10 lakh it would be deducted at 30%) minimum being 10%.  You would get form-16/16A for this deduction from your employer and you would need to show this deduction at the time of income tax return filing. (Not sure about TDS rates, if you know please share it in comments section)

If your income in the year EPF is withdrawn is less than taxable limit (for example you are studying or not found a job) you can claim for refund.

Relief Under section 89 of Indian Income Tax 1962

When salary or other income arrears are received in any particular year, one’s tax liability for that year increases. Simply because one’s total income for that year has increased. But having to pay a higher tax on account of arrears is unfair to the taxpayer. Had he originally received the money in the year(s) that he was supposed to receive it, the additional tax would have been staggered over this time, instead of converging in one year as a lump sum payment.  Section 89(1) of the income tax act is the relief an employee can claim if he receives his salary in advance, arrears( receives salary of earlier year(s)) or receives profits in lieu of salary(ex gratuity, commuted pension). Salary in advance is when employee receives compensations under voluntary retirement scheme (VRS) and has not claim deduction under section 10(10C) of the Income tax . In this condition income will be calculated at higher rate as per section 17(3) of income tax act. Business Standard Reduce Tax Liability on Arrears

Calculation of  relief u/s 89

  • Step 1 : Calculate tax for the current year (including cees and education cess) on income including salary in arrears/advance/ compensations.
  • Step 2 : Calculate tax for the current year (including cees and education cess) on income excluding salary in arrears/advance/ compensations.
  • Step 3 : Step1 – step2
  • Step 4 : Calculate tax for the year in which salary/compensation ought to have been received (including cees and education cess) on income including salary in arrears/advance/ compensations.
  • Step 5 : Calculate tax for the year in which salary/compensastion ought have been received (including cees and education cess) on income excluding salary in arrears/advance/ compensations.
  • Step 6 : Step4 – Step5
  • Step 7 : Relief u/s 89 = Step3-step6 (if positive, otherwise nil)
  • Step8 : Tax paid for Current Assessment year = Step1-step7

Illustration : Mr Mehta works for ABC Ltd. For the Financial Year 2011-12 his taxable income is Rs 12,00,000. On Dec 1 2011 he received arrears of bonus of Rs 60,000 perteraning to year 2007-2008. FOr year 2007-2008 his taxable income was Rs 2,30,000 and he had paid tax of Rs 20,600.  60,000 will be taxable in the year 2011-12. He can claim relief under section 89 as shown below.

Tax rates for FY 2007-2008 : Upto 1,10,000 Nil; between 1,10,000 to 1,50,000 : 10%; between 1,50,000 – 2,50,000 : 20% ; above 2,50,000 : 30%; Education cess : 3%

Tax rates for FY 2011-2012 : Upto 1,10,000 Nil; between 1,10,000 to 1,50,000 : 10%; between 1,50,000 – 2,50,000 : 20% ; above 2,50,000 : 30%; Education cess : 3%

    AY 2007-2008 AY 2011-2012
    (1) (2)
Taxable income without including arrears   2,30,000 12,00,000
Tax on above income(including Cess) A 20,600 2,18,360
Taxable income after including arrears    2,90,000  12,60,000
 Tax on above income(including Cess) B  37,080  2,36,900
 B-A  C  16,480  18,540

In this case relief under section 89 will be 18,540 – 16,480= 2,060. If C(2) would have been less than C(1) then relief under  section 89 would not have been available.

Income Tax Calculation for FY 2011-12(AY 2012-13) will be as follows:

   
Income 12,00,000
Arrears     60,000
Taxable Income 12,60,000
Income Tax 2,30,000
Education Cess     6,900
Total 2,36,900
Less : Relief under Section 89(as calculated above) 2,060
Tax Payable 2,34,840

simpletaxindia RELIEF u/s 89(1) CALCULATOR -AVAILABLE FOR DOWNLOAD explains section 89 in detail and also provides the excel sheet for calculation of Relief under Section 89.

Note: There is confusion regarding whether Relief under section 89  is applicable if withdrawal from PF is within 5 years. Have still covered it. if you know please share it in comments section.

FAQ

Q. Will my withdrawal from PF be taxable If I leave my current organisation?

  • 1. Worked in Company ‘A’ from 2003-2004 (15 months)
  • 2. Worked in Company ‘B’ from 2004-2007 (36 months)
  • 3. Worked in Company ‘C’ from 2007-till date (52 months)
  • I have transfered my PF from “A” to “B” and “B” to “C”.

A:The total period exceeds 5 years and thus withdrawal  is not taxable.

Q. How are 5 years calculated?

Years in which contribution has been made to Provident Fund account are counted. It can be with one employer or more than one employer provided you got your Provident Fund transferred. If you leave your job after 2 years and you do not contribute and do not withdraw or transfer your account for 3 years then still the number of years are still counted as 2 as that’s period in which contribution to EPF was made. Such accounts in which contribution is not made are called dormant accounts. For 3 years after you stop contributing your PF account will earn interest.

Q:I joined a company on 14th Jun 2007  and I resigned on 7th of Jun,2012. I  cannot continue as I am going for further studies. Will my balance in recognised PF would be taxable.if yes,any ways to avoid it?

A:As you will be short by a week your PF withdrawal will become taxable if you withdraw.If you take a break and then join then if transfer your accumulated balance with the present employer to the new employer then there will be no tax implication. If you join within 3 years your PF account will still earn interest.

Q:Provident fund is taxable in which year : at the time of resignation from the job or at the time of withdrawal?

A:PF is taxable in the year you withdraw it if service is less than 5 years.

Q:I have worked in ‘X’ company from Aug 2010 to Aug 2011 and then left the company . Now I want to withdraw my PF. Will it be the taxable income from PF . If Yes then how could i save my tax ?

A: Yes it will be taxable since service is less than 5 years.The tax rate will apply for the financial year in which it was withdrawn. There is no special provision to save tax on PF. You can transfer your PF account to new employer and complete 5 years and then withdraw.

Q: Is TDS applied on premature withdrawal of PF amount before 5 years or everytime you withdraw regardless of the number or years ?

A: TDS is applicable if you opt to withdraw the entire sum in PF balance before expiry of 5 years. TDS is applicable at the rate of your income slab.( Not sure about TDS rates, if you know please share it in comments section)

Q: Can I claim refund on TDS of EPF withdrawal? (Thanks to our reader Ankit for the question)

A: Yes you can claim for refund on TDS of EPF withdrawal  for the year in which EPF is withdrawn. This is helpful if you withdraw in the year when your income is less than taxable limit for example you are studying or not working.

Q: Do we have to show the PF withdrawal while filing return?

If PF is withdrawal less than 5 years then as mentioned earlier it would be taxed as given below.

  • The employer’s contribution and interest, thereon, would be fully taxable as as profits in lieu of salary or ‘salary income’ in the hands of the individual.
  • 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.

While filling the income tax form please file under appropriate section.

If PF withdrawal is after 5 years then it is exempt from tax. You can still show it Income Tax Form under exempt income section like we show PPF Interest (as shown in our article Filling ITR-1 : Bank Details, Exempt Income, TDS Details). (Not sure about this if you know please share it in comments section we would appreciate it )