Tax Treatment of Provident Fund for Calculating Taxable Salary Income

Tax Treatment of Provident Fund for Calculating Taxable Salary

Provident Fund Scheme is a welfare scheme for the benefit of the employees. Under this scheme, certain sum  is deducted by the employer from the employee’s salary as his contribution to the Provident Fund every month.  The employer also contributes a certain percentage of the salary of the employee to the provident fund. These  contributions are deposited/ invested. The interest earned on these investments is also credited to the provident  fund account of the employees. The balance thus keeps accumulating year after year. At the time of  retirement/resignation, the accumulated amount is given to the employee, if certain conditions are satisfied. In this  regard it is pertinent to note the following facts:

(a)        the contribution made by the employees is out of their income and therefore, there is no question of taxing  any contribution made by the employees because the entire amount of the income has already been taxed.  In fact, in such cases he is given a deduction from his gross total income on account of the amount  contributed by him.

(b)        the contribution made by the employer is over and above the salary of the employee and is therefore, an  income deemed to be received by the employee though it is not immediately made available to him.  However, it is exempt upto certain limits.

(c)        the interest credited to the provident fund account of the employee is also an income of the employee over  and above his salary income. However, it is also exempt upto certain limits.

1.  Kinds of Provident Funds:

At present there are 4 types of Provident Funds:

(1) Statutory Provident Fund (SPF):

This fund is set up under the Provident Fund Act, 1925. The Scheme,  under this Act, is mainly meant for Government employees/semi-Government employees,  university/educational institutions affiliated to a university established by statute or other specified  institutions.

(2) Recognised Provident Fund (RPF):

Recognised Provident Fund Scheme is a scheme to which the  Employee’s Provident Funds and Miscellaneous Provisions Act, 1952 applies. According to this Act, any  person who employs 20 or more employees, is under an obligation to register himself under the PF Act,  1952 and start a provident fund scheme for the employees in his organisation. However, there is no  restriction if the employer and the employees of such establishment wish to start a scheme even if the  number of employees is less than 20. The establishment has a choice between the following two  alternatives:

(a)        they may join the government scheme set up by the Provident Fund Commissioner under the  Provident Fund Act, 1952; or

(b)        they may start a PF scheme in their own organisation and get the approval of the Provident Fund  Commissioner.

The first scheme i.e. the Government scheme is already recognised by the Principal Commissioner or  Commissioner of Income-tax but for the second scheme started by the employer and the employees  themselves, they have to create a trust for running such scheme and besides taking the approval of  Provident Fund Commissioner, they have to take the approval from the Principal Commissioner or  Commissioner of Income-tax. In this case, the funds of the Trust are required to be invested in a particular  manner and the income of the Trust is to be claimed as exempt from income-tax. If the CIT grants the  approval, it is called a recognised provident fund scheme.

(3) Unrecognised Provident Fund (URPF):

A scheme started by the employer and the employees in an  establishment, whether approved by Commissioner of Provident Fund or not, but not approved by the  Principal Commissioner or Commissioner of Income-tax is called an unrecognized provident fund.

See also  Exemption of the Family Pension received by the family members of Armed Forces (including para-military forces) Personnel killed in action in certain circumstances [Section 10(19)]

(4) Public Provident Fund (PPF):

This is a scheme, which is covered under Public Provident Fund Act,  1968. Any member of the public, whether in employment or not, may contribute to this fund. Therefore,  even self-employed persons may contribute to this fund. In other words, it is a scheme where there is  assessee’s own contribution only. The employee can deposit money under PPF account in addition to his  contribution to other provident fund schemes. In this scheme there is no employer’s contribution. The  minimum contribution to this Fund is Rs.500 and maximum Rs.1,50,000 per year.

2.  Treatment of Provident Fund for income-tax Purposes

Particulars SPF RPF URPF PPF
1. Employee’s/ assessees’ contribution Deduction under section 80C is available from gross total income subject to the limit specified therein Deduction under section 80C is available from gross total income subject to the limit specified therein No deduction under section 80C is available Deduction under section 80C is available from gross total income subject to the limit specified therein
2. Employer’s Contribution Fully Exempt from Tax Exempt upto 12% of salary. Amount in excess of 12% is included in salary. But the Government has further put a combined cap of  Rs. 7,50,000 retirement funds of
the employee (i.e., Recognized Provident Fund, Superannuation Fund, and NPS). This means if an Employer is Contribution in all specified funds during the previous financial year exceeds Rs. 7,50,000, it will be taxable in hands of employees [Vide Clause (vii) of section 17(2)]
Not exempt but also not taxable every year. For taxability see point 4 below Not applicable as there is only assessee’s own contribution
3. Interest on Provident Fund Fully exempt from tax Exempt under section 10 upto 9.5% p.a.

Interest credited in excess of 9.5% p.a. is included in gross salary

Not exempt but also not taxable every year. For taxability see point 4 below. Fully Exempt
4. Repayment of lump sum amount on retirement / resignation / termination Fully exempt under section 10(11) Exempt subject to certain conditions. See Note-2 Accumulated employee’s contribution is not taxable.

Accumulated employer’s contribution + interest on employer’s contribution (till date) is taxable as profit in lieu of salary.

Interest on employee’s contribution (till date) is taxable as income from other sources

Fully Exempt under section 10(11)

 

IMPORTANT NOTES :

1.         Employer’s contribution and interest on provident fund in the case of unrecognized provident fund are not taxable in the year of contribution or credit of interest. However, when the lump sum amount is received by the employee then it becomes taxable.

2.         The accumulated balance due and becoming payable to an employee participating in a recognised provident fund shall be exempt in the following cases:

(i)       If the employee has rendered continuous service with his employer for a period of 5 years or more, or

(ii)       If, though he has not rendered such continuous service of 5 years, the service has been terminated (a) by reason of such employee’s ill health or (h) by the contraction or discontinuance of the employer’s business or (c) or other cause beyond the control of the employee, or

(iii)      if, on the cessation of his employment, the employee obtains employment with any other employer, to the extent the accumulated balance due and becoming payable to him is transferred to his individual account in any recognised fund maintained by such other employer.

However, in a situation mentioned under clause (iii) above for calculating period of service for clauses (i) and (ii) above, the period or periods for which such employee rendered continuous service under his former employer or employers aforesaid shall also be included.

3.         If the accumulated balance due to an employee participating in a recognised provident fund is paid to him otherwise than in the circumstances referred to above, as for instance, in cases where the employee voluntarily resigns from the post before the completion of 5 years, service with the employer, the amount paid to the employee is brought within the ambit of taxation. In such cases, the employee is required to pay, in addition to normal tax payable by him, an amount equal to the difference between the aggregate tax which would have been payable by him if certain tax concession allowed to the employee’s participating in recognised provident fund had not been allowed to the employee in the years in which he made contribution to the fund and the aggregate tax actually paid by him for these years. In other word’s tax relief or deduction allowed to the assessee shall be withdrawn. Further, the total employer’s contribution plus interest thereon, which was not taxed earlier, shall be taxable as profit in lieu of salary. He can however, claim relief in this regard under section 89. Further, interest on employee’s contribution is taxable as income from other sources. [CIT v Hyatt (G.) (1971) 80 ITR 177 (SC)]

4.         Salary, for the purpose of provident fund includes dearness allowance, f the terms of employment so provide, hut excludes all other allowances and perquisites. As per the Supreme Court’s decision, commission allowed as a fixed percentage of the turnover achieved by the employee, is also included in the basic salary.

EXAMPLE:

From the following particulars of Shri Ram Kishan, a manager of a firm, compute his  taxable income from salary for the assessment year 2020-21.

    Rs.
(i) Basic Salary (p.m.) 23,400
(ii) D.A. (included in Salary for retirement benefits (p.m.) 4,000
(iii) Own contribution towards recognised provident fund (p.m.) 2,880
(iv) Employer’s contribution towards recognised provident fund (p.m.) 2,880
(v) Interest on RPF @13% (p.a.) 46,800
(vi) House Rent Allowance 7,200 (p.m.), rent paid for house at Delhi 13,800 (p.m.)
(vii) Medical Allowance (p.m.) 1,000
(viii) Shri Ram Kishan was also provided with a motor car of 1.3 litre rating for his  official as well as private use by the employer. Express of running and  maintenance including depreciation are 40,000
(ix) Professional tax paid 800

SOLUTIONS :

Computation of Taxable Salary for the assessment year 2022-23

  Rs. Rs.
Salary (23,400 x 12)   2,80,800
DA  (4,000 x 12)   48,000
Interest on RPF (in excess of 9.5%)(46,800 – 34,200)   12,600
House Rent Allowance  
Medical Allowance   12,000
Car (1,800 × 12)   21,600
Gross Salary   3,75,000
Less: Standard deduction 50,000  
Professional tax paid 800 50,800
Income from Salary   3,24,200

House rent allowance is fully exempt as per section 10(13A).

3.  Annual Accretion to the contribution which have been included in the total income as per section 17(2)(viia)

The annual accretion by way of interest, dividend or any other amount of similar nature during the previous year to the balance at the credit of the fund or scheme referred to in section 17(2)(vii) to the extent it relates to the contribution referred to in the said sub-clause which is included in total income under the said sub-clause in any previous year computed in such manner as may be prescribed shall be treated as a perquisite.

Thus, any annual accretion by way of interest, dividend or any other amount of similar nature during the previous year to the balance at the credit of the fund or scheme may be treated as perquisite to the extent it relates to the employer’s contribution which is included in total income.

4.  Transferred balance of Unrecognised Provident Fund (URPF) when it is converted into Recognised Provident Fund

As discussed above, payment from URPF is taxable to the extent of employer’s contribution and interest thereon. On the other hand, payment from RPF is exempt, subject to certain conditions. As such, if URPF is later on converted into RPF, out of the total amount standing to the credit of the employee in the find, the employee may opt to transfer the whole or a part of the accumulated balance to the recognised provident fund. That part of the accumulated balance which is not transferred and which relates to the employer’s contribution and interest thereon is taxable as profits in lieu of salary.

That part of the sum transferred from URPF to RPF is taxable as under:

(i)      It will be assumed, as if, such URPF was recognised right from the beginning.

(ii)     As URPF will be treated as RPF right from the beginning, contribution by the employer every year in excess of 10% of the salary of employee upto assessment year 1997-98 and 12% from assessment year 1998-99 plus interest credited to the provident fund every year in excess of 9.5% shall be aggregated till the date of conversion of the URPF to RPF. This aggregate will be included in the Gross Salary in the previous year in which the conversion took place provided the whole accumulated balance is transferred to recognised provident fund account. Where part of the accumulated balance is transferred to recognised provident fund, then proportionate amount of the aggregate amount thus computed shall be taxable. Further the part of the accumulated balance which is not transferred to the recognised provident fund shall also be taxable to the extent it relates to employer’s contribution and interest thereon and the interest on employee’s contribution included in such accumulated balance will be taxable under the head “income from other source”. In other words, if the contribution by the employer to URPF in the past years was 10% or less than 10% or 12% of the salary, as the case may be, and the interest credited to URPF was 9.5% per annum or less than 9.5% per annum there will be no Transferred Balance. Hence nothing will be taxable.

5.  Approved Superannuation Fund

Like Provident Fund, Superannuation fund is also a scheme of retirement benefits for the employee. These are funds, usually established under trusts by an undertaking, for the purpose of providing annuities, etc., to the employees of the undertaking on their retirement at or after a specified age, or on their becoming incapacitated prior to such retirement, or for the widows, children or dependents of the employees in case of the any employee’s earlier death. The trust invests the money contributed to the fund in the form and mode prescribed, income earned on these investments shall be exempt, if any such fund is an Approved Superannuation Fund.

Tax treatment: The tax treatment as regards the contribution to and payment from the fund is as under:

Employee’s contribution: Deduction is available under section 80C from gross total income.

Employer’s contribution: Contribution by the employer to the approved superannuation fund is exempt upto Rs. 1,50,000 per year per employee. If the contribution exceeds Rs. 1,50,000, the balance shall be taxable in the hands of the employee.

Interest on accumulated balance: It is exempt from tax.

Payment from the fund: Any payment from an approved superannuation fund shall be exempt if it is made:

(i)     on the death of a beneficiary; or

(ii)     to any employee in lieu of or in commutation of an annuity on his retirement at or after a specified age or on his becoming incapacitated prior to such retirement; or

(iii)    by way of refund of contributions on the death of a beneficiary; or

(iv)    by way of refund of contributions to an employee on his leaving the service in connection with which the fund is established otherwise than by retirement at or after a specified age or on his becoming incapacitated prior to such retirement, to the extent to which such payment does not exceed the contributions made prior to the commencement of this Act and any interest thereon; or

(v)     by way of transfer to the account of the employee under a pension scheme referred to in section 80CCD and notified by the Central Government. [Clause (v)]

1.     1. Where any contributions made by an employer, including interest thereon on contributions, if any, are paid to an employee during his life time in circumstances other than those referred to in section 10(13) given above, such amount shall be taxable in the hands of the employee.

2.      2. Where any contribution by an employer (including the interest thereon, if any) are repaid to the employer, the amount so repaid shall be deemed, for the purpose of income-tax, to be the income of the employer of the previous year in which it is so repaid.

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