Calculation of EPF Tax Deduction on Withdrawal

Update:- On 8th March, Finance minister Arun Jaitly made an announcement that government has rolled back the proposal to levy any tax on EPF. This is a big win for middle class.

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During the budget announcements the government announced that it will  tax the EPF which was until now exempt from any kind of taxation. This has spooked the middle class and there is a mood of resentment primarily because these are life long earnings and are generally used to fund children’s marriages, education etc.

While I went through the same set of emotions but was curious to quantify the impact this will have in absolute terms and then pass a judgement on how good, bad or ugly this is for us.

In the attached file i have tried to demonstrate the impact with an example of a  person earning a salary of 5 lacs per annum and receiving an average hike of 7% per annum.

Government has till now given two statements which can be interpreted as follows

  1. During the budget announcement –  Tax applicable on 60 per cent of the corpus of the provident fund at the time of withdrawal (this will wipe off approx 22 lacs of savings. Effectively 18% tax on corpus (principal + interest))
  2. 1 day after budget announcement  – Tax applicable on only the interest accrued on 60 per cent contribution to Employees Provident Fund after April 1, 2016 (this will wipe off approx 6 lacs of savings. Effectively 18% tax on interest accrued)

While the first statement was heavily detrimental on the overall savings, the second one too has a sizable impact (due to compounding effect). But its definitely a better option than the first one.

 


epf-intrest-taxation

 

Click Here to download the file for the example shown in above image

 

Conclusion:  While a lot of people voted for change, increased taxes in such shape and form is what they would not have even dreamt in nightmares. This will be a very bitter pill for  middle class to digest.

 
 

Pros for Government:

 

Matching Costs to Expenses. A recent very recent article in economic times speaks about this at length. It says it would have reduced the annual deficit of 50000 cr to 10000 cr  (Time for a closer look at the black-hole called EPS – The Economic Times)

 

Pros for Public:

 

None.

 

While it can be argued that if invested in annuity  the amount will be tax free. But at the age of 60 the decision to expense or invest should be driven by personal choice. 

 

As government hasnt said what they will end up doing with this money. And as a practice they will never tell. So you are being taxed more and dont know how the government is utilizing the funds. One such example is bailing out banks for corporate loan defaults. So likes of Mr. Mallaya are able to take big corporate loans because of their contacts and supposed bribing bankers. When they arent able to pay the financial health of banks suffers and to save the economy the government bails out the banks using our money.

 

Cons for the Government:

 

The impacted people are the ones who have voice. Unlike earlier they can become a force with help of social media. The petition to withdraw the tax  – Withdraw budget 2016 proposal to tax Employee Provident Fund #EPFNoTax  – has already more than 150,000 signatures.

 

It is too much negative publicity for the government with a very high multiplier effect. While government may assume that this decision is impacting only the 70 lakh middle class people. It has failed to recognize that they will lose the votes of these people’s family members and relatives too.

 

Also the aspirational people who are not part of this 70 lakhs group and who look forward to join this group in next 3 to 4 years may also turn hostile to the governments decision.

 

Cons for Public:

 

If you see the outgo due to this decision. You will understand the gravity of the problem at hand. I have tried to quantify the problem with the help of an example above.

 

Government is trying to correct the legacy by playing a T20 match here. But the solution maybe in playing a test match or test match series so that shock can be absorbed well in bits and pieces.

 

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