Is Rationalization of Tax Treatment of Retirement Schemes Really Rational?

Last Updated : March 15, 2016, 7:11 a.m.

Budget 2016 has come out with a whooping change on the taxability of retirement benefits and the whole nation has evoked strong opposition towards it. Before deep diving into the proposal, let us find out what the existing law states.

Existing law:

a.) National pension Scheme (NPS)

Under the existing provisions of our law, tax treatment for the NPS comes under Exempt, Exempt and Taxable (EET) methodology.

In simpler terms, the following is the tax treatment:

• Contributions: The monthly/ periodic contributions during the pension accumulation phase are allowed as a deduction from your taxable income upto a limit of One lakh rupees, and your tax will subsequently get reduced
• Returns: The returns generated on these contributions during the accumulation phase are also exempt from tax
• Withdrawals: The terminal benefits on exit, in the form of lump sum withdrawals are taxable in the hands of the individual or his nominee in the year of receipt of such amounts.

b.) Employee’s Provident Fund (EPF)

Currently EPF enjoys the Exempt, Exempt, Exempt (EEE) status.

The tax treatment is as follows:

• Contributions: The contributions are exempt upto a limit of One Lakh Fifty Thousand Rupees
• Returns: The returns generated are exempt
• Withdrawals: Lump sum withdrawals are exempt from tax, when withdrawn after 5 years of continuous service

c.) Superannuation Funds

Under the existing provisions, tax treatment is as follows:

• Contributions:
  • Employee’s contribution : Employee’s contribution to an approved superannuation fund is eligible for deduction under section 80C, i.e. Exempt
  • Employer’s contribution: Employer’s contribution towards an approved superannuation fund is exempt from tax upto 1 lakh per annum. If the employer makes any contribution beyond 1 lakh such excess shall be taxable for the employer.
• Returns: Interest earned from an approved superannuation fund is exempt from tax.
• Withdrawals: Any payment from an approved superannuation fund made to an employee in lieu of or in commutation of an annuity on his retirement at or death or on his becoming incapacitated prior to such retirement is exempt from tax. Other than these situations, it is fully taxable in the hands of the employee.

Thus there was a great disparity in the tax treatment of different retirement benefits available.

Proposed Law:

In order to bring uniformity in the tax treatment of these retirement plans, it is now proposed to bring all retirement plan under one umbrella in respect of taxability. The Budget 2016 proposes the following:

a.) EPF & Superannuation funds:

In respect of contributions made on or after April 1, 2016 by an employee participating in a recognized provident fund and superannuation fund, upto 40% of the accumulated balance attributable to such contributions on withdrawal shall be exempt, i.e. 60% shall be taxable!

b.) NPS:

40% of the payment from National Pension System Trust to an employee on account of closure or his opting out of the pension scheme, shall be exempt from tax and the remaining would be taxed as per the Income Tax slabs in the year of receipt.

The good news:

• These amendments are proposed to be made effective prospectively and the existing savings are not impacted in any way.
• There is no change for people who are the members of recognized provident fund and who are within the statutory wage limit of salary of Fifteen thousand per month.
• The whole amount received by the nominee, on death of the assessee shall be exempt from tax. This is applicable in all the three cases.
• There is no change in treatment of Public Provident Funds, so PPF withdrawals continue to be tax free.

The Finance Ministry has clarified its proposal by providing that the government wants to encourage private sector employees to go for pension security after retirement instead of withdrawing their entire money from their EPFs. Thus, if the remaining 60% of the corpus withdrawals is invested in Annuity, it shall be fully tax free since it can provide regular pension.

In a view to bring parity, although government has managed to make NPS contributors happy but simultaneously by reducing the exemption to 40% for EPF contributors, it has really made the nation agitated. I am sure our Honorable Finance Minister would have received tons of representations from amongst a lot of sections of the society.

As of now, with such a rage and widespread oppositions, it has been clarified that the proposed changes will be revisited and reviewed. Let us see if this provision is rolled back or not.