Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Economy

Update from Finmin: PPF Is Not Taxable, But EPF Corpus is Taxable at Exit And More

This is an update to our (very popular) post on Clearing the Confusion on how EPF is Taxed in Budget 2016.

The Finance Ministry has released a note confirming EXACTLY what we have said here, despite statements to the contrary made on various TV channels. Here’s the note

Essentially:

  • PPF is unaffected. No change, No tax on exit. 
  • EPF Is taxable at exit. If you earned less than 15,000 rupees a month when you retire, you don’t pay this exit tax. 
  • The idea is to discourage taking full PF when you retire, as a lumpsum. Take 40%, no tax. The remaining 60% if you do take, you are taxed on it (at retirement)
  • Note: it’s 60% of the whole corpus, not interest.
  • If you use this 60% to buy an annuity from an insurer, then there is no tax. Now this needs a clarification that it’s not really taxed – because technically the money comes to you and you buy an annuity, so it’s income in your name. I think the concept may be hidden in the tax code, but I haven’t been able to find it.
  • The annuity pays you a monthly amount. This monthly amount is taxable. (Please don’t believe what someone has “said”. Income from annuities is taxable, nothing has changed there)
  • If you die and the remaining annuity goes to your heirs, they don’t pay tax. (basically, we can’t enjoy our money, our heirs can)
  • Employees and Employers can both contribute whatever they want, but only 1.5L (each) is allowed as an exemption. 
  • People have asked that only the accumulated interest be taxed, not principal. And that the input limits should be removed (currently 1.5L on both employer and employee contributions). They will think about it, so these changes have not yet happened.

Please note.

There is a lot of drama happening. Everyone’s furious. But this has to happen someday – retirement savings have to be taxed at exit as part of the EET regime. However, in this case, it’s piecemeal – firstly, we should have a uniform approach for everyone (so even PPF, Insurers, ELSS etc should have a tax on exit), or nothing should. Secondly, remember that EPF is mandatory for most people and most companies don’t even know they can have employees opt for a lower amount; the EPFO should let them lower that liability. Thirdly, the EPF you pay in is not fully tax exempt so this amounts to double taxation for the richer employees.

The law protects past investments but applies to fresh investments made in the future. EPF should be only used in the most minimum quantities primarily because the quality of annuities in India are waay lesser than equivalent products. An annuity for life with return of premium to your heirs gives you a return of about 6.7% today (Rs. 6,700 per year for one lakh invested) which is taxable. If you had the corpus, you could invest in tax free bonds and get an income of 7.5% tax free. Annuities make no sense to buy, but we now are forced to buy them.

Our Suggestions

At Capital Mind, the EET regime is not something we abhor. But we require a level playing field for all long term tax saving products. If you saved tax going in, you’re going to be taxed getting out. That should apply for everything.

So there are two real problems with the EPF and the EET regime. For many, it’s TET. (Since the entry amount is often paid from post tax income) and thus it amounts to double taxation of the same amount. Imagine you had Rs. 100 and you paid Rs. 30 tax on it, and invested the Rs. 70 into the EPF. The Rs. 70 after many years becomes Rs. 150, and now 60% of it is taxed again! This is not new (dividend distribution tax is a form of double taxation) but is strange to do. A better solution is to simply state that all input into EPF is 100% tax free, and all output is 100% taxed. 

Another problem is that annuities from insurers are crap in India, and the annuity income is taxable. Instead of demanding that the EPF corpus is invested in annuities, the government should state that the money could be invested in a) government bonds and b) tax-free bonds just the same as annuities. With the rider that they cannot sell and must reinvest any principal if it matures. (Otherwise the money gets taxable) People can drip-sell and reduce tax liability on their own. 

Not that this will happen, but still, there’s a need for suggesting solutions other than “roll it all back”.

Like our content? Join Capitalmind Premium.

  • Equity, fixed income, macro and personal finance research
  • Model equity and fixed-income portfolios
  • Exclusive apps, tutorials, and member community
Subscribe Now Or start with a free-trial