Premature Provident Fund withdrawal attracts tax
Provident Fund would be taxable in the hands of employee if he has worked for less than 5 years except in specified conditions stipulated below.
The provident fund (PF) is one of the most popular retirement benefit schemes in India. It is also considered as a tax-saving investment for contributions (employer up to 12% of basic salary and employee up to overall deduction of R1 lakh) made towards an approved/recognized PF, the year-on-year accruals and the amount received on maturity from such funds is tax exempt.
In most cases, the accumulated PF balance is withdrawn at the time of retirement, and therefore, not taxable in the hands of the individual. However, in certain cases like change in employment, an individual may even withdraw the PF balance earlier. The point one needs to remember is that the amount received from such PF is not exempt from tax in all cases. Only under the circumstances listed below will the amount withdrawn from PF be eligible for such exemption from tax.
- If the employee has rendered continuous service with the employer 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.
In short, where the PF amount is withdrawn before five years of continuous service, it may be taxable in the hands of the individual as if the fund was not recognised from the start of the contributions. In such a case, payment received by the individual in respect of the employer’s contribution along with the interest accrual thereon is taxed as “salary”. Interest on the employee’s contribution is taxable as “other income”. Payment received in respect of the employee’s own contribution is exempt from tax (to the extent not claimed as a deduction earlier).
I-T provisions provide that the trustees of a recognised PF or any person authorised by the regulations of the fund to make the payment of the accumulated balance to the employee should deduct tax at source while paying the amount. Further, the person liable to deduct tax has to issue the certificate of tax deducted at source (Form 16) within the specified time frame to the employee depicting the details of taxes withheld from the accumulated PF balance and also comply with other salary-related compliance necessities. So the next time you think of withdrawing your PF, you must as an individual also assess whether the same is taxable or exempt.
Q. I worked for a private company for two years where I had a provident fund (PF) account. I then went for higher education and post that I am working with a government-run firm. My current organization provides facility of National Pension System (NPS) rather than PF. My PF account with my previous organization is inactive for more than two years. I am afraid it will not earn interest once it completes three inactive years. Also, if I go for withdrawal, it will be taxable. I do not want to withdraw it or pay tax. I would rather like to keep this money invested and earn interest. Suggest if there is some solution (investing into another PF or Public Provident Fund, or PPF, account, continuing the existing PF account, transfer to my NPS account) or any other way through which it continues to grow.
Ans. You are correct and your PF account has become inactive and will not earn any interest after the three year period is over. In the current scenario, your options are limited. You cannot transfer the PF to an NPS account. And continuing the PF is not recommended as you will not be earning any interest. Currently the option to switch from PF to NPS is also not available and tax cannot be avoided.
Hence, the option left is to withdraw. Your PF account will become taxable as you do not satisfy the criteria defined by the Income-tax Act. As per the Act, recognized PF is eligible for exemption from tax only if the employee has rendered continuous service to the employer for five years or more. In case the balance is transferred from the previous employer then the years with previous employer is also included.
In your case, as you have not rendered service for five years and there is a break after the first job, the PF becomes taxable and even if you do not redeem the same and continue holding it, you will be just deferring your tax liability. The tax liability will be on the employer’s contribution and the interest received. Payment received for your own contribution is exempt from tax if it is not claimed as deduction earlier.
And to ensure growth in corpus, you can open a PPF account and invest the proceeds and in case the amount received is more than the maximum permissible amount in PPF (Rs.1 lakh), the same can be invested in the next fiscal. Alternatively you can also invest in NPS.
You can also consider investments in debt mutual funds wherein you can invest in medium- and long-term debt. You can consider equity as an asset class as your investment horizon is long term. If you have a low risk appetite, you can have a low or moderate exposure to equity. But equity helps in providing an inflation-adjusted return if held for long term.