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Tax Treatment of Provident Funds (PF) for Salary Income

To encourage savings for the social security of employees, the Government has set up various kinds of provident funds. The employee contributes a fixed percentage of his salary towards these funds and in many cases employer also contributes. The whole contribution along with interest is credited to employee’s account. He will get payment out of this fund at the time of retirement and at some other important occasions. If the employee dies, his heirs will get the full payment.

Provident Funds are of four kinds

(i)       Statutory Provident Fund or the Fund to which the Act of 1925 applies (S.P.F.).

(ii)      Recognised Provident Fund (R.P.F.).

(iii)     Unrecognised Provident Fund (U.R.P.F.).

(iv)     Public Provident Fund (P.P.F.).

 Statutory Provident Fund (SPF)-

Statutory provident fund is set up under the provisions of the Provident Funds Act, 1925. This fund is maintained by the Government and the Semi-Government organisations, local authorities, railways, universities and recognised educational institutions.

 Recognised Provident Fund (RPF)-

A provident fund scheme to which the Employee’s Provident Fund and Miscellaneous Provisions Act, 1952 (hereinafter referred to as PF Act, 1952) applies is recognised provident fund. As per PF Act, 1952 any establishment employing 20 or more persons is covered by the PF Act, 1952 (establishments employing less than 20 persons can also join the provident fund scheme if the employer and employees want to do so). An establishment covered by the PF Act, 1952 has the following two alternatives and may join any of the following two schemes —

Alternative schemes available

Additional formalities to get approval
of the Provident Fund Commissioner

Status for income-tax purpose

1. Scheme of the Government set up under the PF Act, 1952

No

Such a provident fund is recognised provident fund

2. Own scheme of provident fund

A trust has to be created by the employer and employees to start own provident fund scheme. Funds shall be invested in accordance with the rules given under PF Act, 1952. If the scheme satisfies certain rules given under PF Act, 1952, it will get the approval of the PF Commissioner.

If it is recognised by the Commissioner of Income-tax in accordance with the rules contained under Part A of the Fourth Schedule to the Income-tax Act, it becomes recognised provident fund.

Unrecognised provident fund -

As stated in 2 supra (third column), if a provident fund is not recognised by the Commissioner of Income-tax, it is known as unrecognised provident fund.

Public provident fund -

The Central Government has established the public provident fund for the benefits of general public to mobilise personal savings. Any member of the public (whether a salaried employee or a selfemployed person) can participate in the fund by opening a provident fund account at the State Bank of India or its subsidiaries or other nationalised banks. Even a salaried employee can simultaneously become member of employees’ provident fund (whether statutory, recognised or unrecognised) and public provident fund. Any amount (subject to minimum of Rs. 500 and maximum of Rs. 1,50,000 per annum) may be deposited under this account. The accumulated sum is repayable after 15 years (it may be extended). This provident fund, at present, carries compound interest at the rate of 8.7% per annum. Interest is credited every year but payable only at the time of maturity.

Treatment of Provident Fund for Income Tax purpose :

Statuton Provident
Fund (SPF)

Recognised Provident
Fund (RPF)

Unrecognised Provident
Fund (URPF)

Public Provident Fund (PPF)

1

2

3

4

5

Employer’s contribution to provident fund

Exempt from tax

Exempt up to 12% of salary. Excess of employer’s contribution over 12%of salary is taxable

Exempt from tax

Employer does not contribute

Deduction under section 80C on employee’s contribution

Available

Available

Not Available

Available

Interest credited to provident fund

Exempt from tax

Exempt from tax if rate of interest does not exceed notified rate of interest; [ i.e. 9.5%] excess of interest over notified rate of interest is taxable

Exempt

Exempt from tax

Lump sum payment at the time of retirement or termination of service

Exempt from tax

Exempt from tax in some cases when not exempt provident fund will be treated as an unrecognised fund from the beginning

See Note 3

Exempt from tax

Notes:

  1. “Salary” here means basic salary. It includes dearness allowance and dearness pay, if terms of employment so provide. It also includes commission where commission is determined at a fixed percentage of turnover achieved by an employee.

  2. Accumulated balance payable to an employee participating in a recognized provident fund shall be exempt in the hands of employee in the following situations –

    • If the employee has rendered continue service with his employer for a period of 5 years or more. For the purpose of calculating 5-year time-limit, service rendered with the previous employer shall be included, if the previous employer also maintained recognized provident fund and the provident fund balance of the employee was transferred by him to the current employer.

    • If the employee has been terminated because of certain reasons which are beyond his control (e.g., ill health of the employee, discontinuation of business by employer, completion of project for which the employee was employed, etc.).

    • If the employee has resigned before completion of 5 years but he joins another employer (who maintains recognized provident fund and provident fund money with the current employer is transferred to the new employer).

    • If the entire balance standing to the credit of the employee is transferred to his account under a pension scheme referred to in section 80CCD and notified by the Central Government (i.e., NPS).

  3. Lump sum payment received from unrecognized provident fund at the time of retirement/termination shall be taxable as follows –

    • Payment received in respect of employer’s contribution and interest thereon is taxable under the head “Salaries”.

    • Payment received in respect of interest on employee’s contribution is taxable under the head “Income from other sources”.

    • Payment received in respect of employee’s contribution is not chargeable to tax.

What Is The Tax Treatment Of 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 ₹1,50,000 per year per employee. If the contribution exceeds ₹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:

  1. on the death of a beneficiary; or

  2. 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

  3. by way of refund of contributions on the death of a beneficiary; or

  4. 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

  5. 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) inserted by the Finance Act, 2016, w.e.f. A.Y. 2017-18]

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 fund, 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:

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

  2. 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 employers contribution and interest thereon and the interest on employees 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.

 Important Links....for calculating Salary Income

(A). Salary -Definition & Meaning
(B). Provident Fund
(C). Allowance
(D). Perquisites
(E). Profit in lieu of Salaly
(F). Retirement Benefits
(G). Deductions
(H). Table Presentation of Salary Income (Section 15 to 17)

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