INTRODUCTION
In 2014, major amendments were made to the Employees’ Pension Scheme (EPS) 1995. The amendments have had significant effects on the contribution made to the Pension Fund as well as the method of claiming the benefits. While the amendments affected the scheme beneficiaries, they also gave rise to some complex tax implications on income that had not been contemplated before. Specifically, contributions exceeding the statutory wage ceiling have been restricted. This has complicated the process of claiming higher pension benefits. It has posed legal and tax-related challenges to the stakeholders.
This blog will present a comprehensive analysis of the income tax implications resulting from the transfer of funds from the EPF to the Pension Scheme, contributions made to the Pension Scheme, and pensions received at retirement.
BACKGROUND
The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, is one of the most important legislations in India that governs some of the most important schemes for retirement benefits of employees, including the Employees’ Provident Fund Scheme (PF Scheme), Employees’ Pension Scheme (Pension Scheme), and Employees’ Deposit-Linked Insurance Scheme (EDLI Scheme). The PF Scheme provides an option for lump sum receipt at the time of retirement, while the Pension Scheme provides a regular flow of pension receipts after retirement.
Before 2014, employees were allowed to contribute up to 8.33% of their salary to the Pension Fund, and even if their salary exceeded Rs 15,000, where they could still get their “higher pension” contribution in place. This facility was curtailed in the subsequent amendment in 2014. Employees were made to opt for the decision of continuing with higher pension contributions; in case they did not do so, the amount that would otherwise have been used towards the higher pension would automatically go into their Provident Fund.
This was challenged by some employees in various High Courts, and finally, the issue came before the Supreme Court. The Court upheld the amendment but at the same time extended the date for the employees to opt for the more lucrative pension scheme. Thereafter, EPFO released circulars to bring about the changes. While the legal framework is clear, the amendments have brought about a lot of unforeseen implications for income tax, particularly about the transfer of funds from the Provident Fund to the Pension Scheme, treatment of employee contributions, and tax implications regarding pension pay-outs.
TRANSFER OF FUNDS FROM THE PROVIDENT FUND TO THE PENSION SCHEME
One of the important implications of the 2014 amendment is that funds can be transferred from the Provident Fund to the Pension Scheme. Now, as per the circulars issued by the EPFO[1], the employees are allowed to transfer the employer’s contributions, which were earlier deposited in the Provident Fund, to the Pension Fund. This will help employees to take advantage of the better pension scheme. This transfer reduces the balance of the Provident Fund as the funds are transferred to the Pension Scheme.
From an income tax perspective, these transfers raise important questions about their tax treatment. The income tax implications are primarily addressed in Section 10(12) of the Income Tax Act, 1961 (IT Act)[2], which offers tax exemptions on amounts received from a recognized Provident Fund. According to this provision, as long as the conditions outlined in Rule 8 of the Fourth Schedule of the IT Act[3] are satisfied—such as continuous service for a minimum period of five years—the amounts transferred from the Provident Fund to the Pension Scheme can remain exempt from tax.
However, since the transfer involves transferring funds to another scheme, it would seem that such amounts could no longer qualify as part of the Provident Fund, thereby disqualifying them from the exemption under Section 10(12). For one thing, the tax exemption does not lose its justification entirely based on this argument, and after all, the primary function of the Employees’ Provident Funds Act is to incentivize saving for retirement for the employees and to provide these savings with associated tax advantages. The argument, by stressing the need for further elucidation from the tax department, is that the aim now is not to penalize the employees.
CONTRIBUTION TO THE PENSION SCHEME FROM THE PROVIDENT FUND
The second income tax implication under consideration is the voluntary withdrawal of funds from the Provident Fund for the purposes of contributing to the Pension Scheme, as provided by the recent EPFO circulars. This is a one-time opportunity provided to employees to increase their contributions to the Pension Scheme in line with a salary increase.[4]
For tax purposes, the voluntary withdrawal of the amounts from the Provident Fund to make this contribution is considered income for the employee in the year of withdrawal. It is important to note that this withdrawal is not automatically exempt from tax as it is a decision of the employee to use his Provident Fund balance to contribute to the Pension Scheme, rather than for retirement expenses or other contingencies.
Consequently, the withdrawn amounts get added to the employee’s overall income for the relevant assessment year and would be subject to income tax, save as otherwise exempted by special provisions under the prevailing tax legislation. Additionally, the tax implications would be mitigated further by the employee’s ability to avail of deductions under Section 80C of the Income Tax Act[5], which provides for tax-deductible contributions toward retirement savings schemes. However, it is worth noting that this provision does not exempt one completely from taxation, especially in cases of voluntary withdrawals.
TAXATION OF PENSION PAYOUTS:
The last of the considerations of income tax implications deals with the taxability of pension payouts made under the Pension Scheme. Pension payouts are generally considered to be “profits in lieu of salary” under Section 17(3)(ii) of the Income Tax Act[6]. The taxation of pension payouts, however, is also affected by a variety of factors, such as whether the pension is from an employer or whether it has originated from a Provident Fund or Pension Scheme.
Section 17(1)[7] deals with the taxation of salaries and, in broad terms, defines the term “salary” to include pension payments made by the employer. Payments made through Provident Fund or Pension Scheme, however, do not qualify as salary in that they are not directly issued by the employer. Instead, the payments are taxed as “profits in lieu of salary,” except for the specific inclusions mentioned in Section 17(3)(ii) of the Act[8].
Understanding the difference between pension payments from an employer and those from a Provident Fund or Pension Scheme is important in determining their tax treatment. Payments received from a Pension Scheme are not directly termed as salary under Section 17(1); however, they are considered “profits in lieu of salary” under Section 17(3)(ii), subject to the condition that they do not comprise employee contributions or the interest accrued on such contributions.
The taxation of pension payouts from the Pension Scheme is further complicated by the nature of contributions made to the scheme. Employee contributions, along with interest earned on those contributions, are not taxed upon receipt.[9] However, any pension amount linked to the employer’s contributions or interest accrued on those contributions may be taxable subject to the relevant provisions of the Income Tax Act.
SUGGESTIONS
To navigate potential tax complications associated with contributions to the Pension Scheme, employees should take the following steps:
- Timely Compliance: Ensure that all actions regarding contributions to the higher pension scheme are in line with the EPFO circulars and adhere to any deadlines set for opting into the scheme.
- Understand Fund Transfers: Carefully consider the tax implications of transferring funds from the Provident Fund to the Pension Scheme. Withdraw funds only when necessary to minimize tax liabilities.
- Professional Guidance: Seek expert advice regarding the tax treatment of pension payouts. Proper planning for retirement benefits is crucial to optimize tax efficiency and ensure compliance with relevant tax laws.
CONCLUSION
In essence, the Employees’ Pension Scheme amendment of 2014 has changed the way retirement benefits in India are taxed. In theory, the legal and constitutional framework of the Pension Scheme now becomes clearer, but there remains much need for employees to watch their tax implications on both their contribution and withdrawal. For purposes of income tax, implications under the transfer of Provident Fund balances to the pension schemes, treatment of contributions under provident fund and pension payouts, and taxation of them become paramount. The employees should account for them to minimize their tax consequences. Because of the depth that the situation entails, individuals necessarily require professional tax advice about how to navigate these effects.
Author(s) Name: Alisha Garg (Symbiosis Law School, Pune)
References:
[1] ‘Circular No. Pension/2022/56259/16541’ (Employees’ Provident Fund Organisation, 20 February 2023) <https://www.epfindia.gov.in/site_docs/PDFs/Circulars/Y2022-2023/Signed_Circular_SC_Pension_20022023.pdf> accessed 15 January 2025
[2] Income-tax Act 1961, s 10(12)
[3] Income-tax Act 1961, sch IV r 8
[4] ‘Frequently Asked Questions’ (Employees’ Provident Fund Organisation) <https://www.epfindia.gov.in/site_en/FAQ.php> accessed 07 January 2024
[5] Income-tax Act 1961, s 80C
[6] Income-tax Act 1961, s 17(3)(ii)
[7] Income-tax Act 1961, s 17(1)
[8] Income-tax Act 1961, s 17(3)(ii)
[9] Manu Sebastian, ‘EPF Pension Case: 2014 Amendment Not Whimsical, Classification Based on Salary Reasonable, Reasons Cited by Supreme Court’ Live Law (05 November 2022) <https://www.livelaw.in/top-stories/epf-pension-case-2014-amendment-not-whimsical-classification-based-on-salary-reasonable-reasons-cited-by-supreme-court-213319> accessed 07 January 2024
