The proposed Contingency Fund interest tax came like a thunderclap for high earners and HNIs who send huge sums of money to this tax-free paradise. Although the tax only applies to contributions above Rs 2.5 lakh per year and will only apply to employee contributions, many provident fund subscribers are unhappy.

This is not the first time that the government has proposed to tax the Contingency Fund money. The 2016 budget proposed that the accrued interest on 60% of the EPF be taxed. The proposal was quashed after a massive outcry against the new levy. However, this year’s proposal might not face such a big backlash as it only concerns the creamy layer of employees. Officials from the Ministry of Finance estimate that less than 1% of Contingency Fund subscribers will be affected. The annual threshold of Rs 2.5 lakh means that a person contributing up to Rs 20,833 per month to the Provident Fund (base salary Rs 1.73 lakh per month) will escape tax.

While it is true that very few subscribers have a base salary of over Rs 1.73 lakh per month, which places their 12% contribution to the Contingency Fund above the tax exemption threshold. of Rs 2.5 lakh, it is also true that a significant number of salaried employees use the Voluntary Provident Fund to invest more than the mandatory 12% of the base salary. “The proposed tax will affect high income earners who use the Voluntary Contingency Fund to earn non-taxable interest,” said Amit Maheshwari, Partner, Partner, AKM Global.

How much can you invest in PF without paying tax
The compulsory PF contribution is 12% of the basic salary. Anyone with a base salary of up to Rs 1.73 lakh will not exceed the tax exemption limit


All figures in Rs; the calculation assumes a yield of 8.5% of PF


The PF contribution can be increased

The new Wages Code adds another complexity to the issue. The new Salary Code, which comes into force on April 1, provides that the basic salary must be at least 50% of the individual’s total income. This means that the salary structures will have to be rearranged with a higher base salary, which will automatically increase the individual’s contribution to the Contingency Fund.

Under the new code, the basic salary must represent at least 50% of the total income.
If the base salary is increased, the PF contribution will increase in the same proportion

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Vikas Dogra is only contributing Rs 2.4 lakh to the contingency fund at the moment, so it will not be affected. But after the Delhi-based financial professional joined a new company in April, part of his contribution to the contingency fund will become taxable. “The compensation structure under the new salary code means that my base salary will be close to Rs 2.5 lakh and the annual contribution to the contingency fund will be close to Rs 3 lakh,” Dogra said. With Rs 2.5 lakh of his contribution earning 8.5% and Rs 50,000 earning 5.85% after tax (in the 30% bracket), his overall PF returns will drop to 8.06%.

Lower yields of FP
Like Dogra, underwriters with high salaries and those who contribute more than the mandatory 12% will earn lower returns on their provident fund. The larger the contribution to the contingency fund, the lower the return.

How the tax cuts are coming back
Weighted returns after interest on the contribution in excess of Rs 2.5 lakh are taxed.

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The calculation assumes returns of 8.5% for PF and 7.1% for PPF

Financial experts are not really surprised by the decision to tax the interest of the Contingency Fund. “It’s a fiscal anomaly. The change was long overdue, ”says Amit Kumar Gupta, portfolio manager for PMS at Adroit Financial. Others believe the tax will push investors into other more lucrative options. “High income earners shouldn’t binge on fixed income. They should reduce the VPF contribution to Rs 2.5 lakh and invest the rest in the NPS. They can claim an additional tax deduction of Rs 50,000 under Sec 80CCD (1b) and potentially earn higher returns, ”says Sudhir Kaushik, co-founder of the tax reporting portal Taxspanner.com.

The new tax is another attempt by the government to streamline the tax exemption for high-income earners. Last year’s budget capped the tax exemption on employers’ contribution to the provident fund, NPS and retirement fund at Rs 7.5 lakh. While this only affected employees with very high salaries, this year’s proposal has a wider impact.

PPF not included in the limit of Rs 2.5 lakh

For provident fund aficionados, however, there is some relief. The government has specified that the limit of Rs 2.5 lakh will not include contributions to the Public Provident Fund (PPF). Many people feared that the PPF contribution would be included in the limit of Rs 2.5 lakh, which would have reduced the exit trap for contributions to the Voluntary Contingency Fund.

Investors who invest heavily in the VPF and are concerned about the proposed tax should invest up to Rs 2.5 lakh in the contingency fund and then opt for the PPF where their investments will generate higher returns and remain tax free. . It is only if they have more to invest after exhausting the annual investment limit of Rs 1.5 lakh in the PPF that they should opt for the VPF.

Only PPF offers higher yields than VPF
But the Post Office program has an annual investment limit of Rs 1.5 lakh.

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Although the VPF pre-tax rate is higher than that offered by the PPF, the postal system offers other unparalleled advantages. Unlike VPF, PPF accounts can be extended beyond retirement in five-year increments. You can also make partial withdrawals from the corpus. In the event of VPF, the account becomes inoperative and ceases to generate interest if it is not withdrawn within three years of retirement.

High-value Ulips lose their advantage
The budget plans to shut down another tax-free haven for HNIs. Under section 10 (10d), earnings from an insurance policy are exempt from tax if the coverage is 10 times the annual premium. The budget proposed to remove the tax exemption from Ulips with a premium of over Rs 2.5 lakh per year. These Ulips will now be treated as equity mutual funds, with gains of over Rs 1 lakh taxed at 10%. It is important to note that this ceiling of Rs 2.5 lakh is the overall premium for all policies held by an insured, which means that one cannot exceed the tax by investing in several policies of less than Rs 2 , 5 lakh.

This will not apply to existing Ulips, but only to new policies purchased after the budget announcement. While most budget proposals typically go into effect from the following fiscal year (April 1), this goes into effect immediately, thus closing the Ulips purchase window before fiscal year end.

Insurance companies are upset by the proposal, but most remain silent. “The increase in the FDI limit for the insurance sector from 49% to 74% is a positive step. But the change in taxation for Ulips would have an impact on such investments. The tax reduces the competitive advantage Ulips enjoyed over other investments, ”said Tarun Chugh, Managing Director and CEO of Bajaj Allianz Life Insurance.


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