#EPFnotax: Six reasons why taxing EPF was a stupid idea in the first place


Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

The Narendra Modi government has decided to withdraw their plan to tax the corpus accumulated by investing in the Employees’ Provident Fund(EPF). As the finance minister Arun Jaitley said in the Lok Sabha today: “In view of representations received, the government would like to do a comprehensive review of this proposal and therefore I withdraw the proposal.”

This is a sensible decision to withdraw what was basically a very stupid idea at multiple levels.

a) The finance minister Arun Jaitley in his budget speech had said that only 40% of the corpus accumulated by investing in EPF would be tax free. This would apply on investments made after April 1, 2016.

The entire 100% accumulated corpus could be made tax free by investing 60% of the corpus in annuities. Annuities are essentially policies sold by insurance companies which can be used to generate a regular income.

The trouble is that most annuities in India give a return of around 5-7%. Given this, they remain a bad way to invest a large corpus. Even investing in a long term fixed deposit can give you a better return.

Some savings bank accounts also pay more than the returns that can be generated by investing in annuities. The annuities in their current are essentially nothing but a rip-off and anyone in their right mind would stay away from investing in them.

Then there is the Senior Citizens Savings Scheme, which allows a senior citizen to invest up to Rs 15 lakh. The scheme pays an interest of 9.3%per year. Given that better returns are available elsewhere, why force people to invest 60% of their provident fund corpus into annuities paying 5-7% per year.

b) Also, the change applied only to private sector employees with a salary of greater than Rs 15,000. This meant that the government employees investing in the General Provident Fund (GPF) or employees of public sector companies investing in other recognised provident funds, could withdraw 100% of their accumulated corpus and need not have paid any income tax on it.

Why was the change proposed only for private sector employees? Why was this distinction made on the basis of the employer? If the idea was to tax, the tax should have applied to everyone and not just the private sector employees.

In the way things had been proposed, a private sector employee making Rs 16,000 per month would have had to pay a tax on the accumulated corpus. A government employee need not have done anything like that. How is that fair and equitable?

c) The government has defended this move on the logic of moving towards a “pensioned society”. As the clarification issued by the ministry of finance a few days back pointed out: “The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account.”

Why was only the private sector encouraged to move towards a pensioned society? Also, what about those people who are earning less than Rs 15,000 per month. Their need for a regular income after retirement is even greater than those making more money.

d) Also, why make only EPF and other recognised provident funds taxable at maturity. Why leave out the Public Provident Fund? Shouldn’t self-employed professionals who invest in PPF to possibly accumulate a retirement corpus, also be encouraged to become a part of the pensioned society?

e) The government also planned to tax the principal amount invested in the EPF. How fair is this? While calculating capital gains for investments made in stocks or real estate, the principal amount is not included. Also, investments made in real estate and debt mutual funds get indexation benefits, where the impact of inflation is taken into account while calculating the cost of purchasing the asset. This brings down the capital gains on which income tax is paid.

Further, there is no tax on long-term capital gains made on stocks and equity mutual funds. Taking all this into account, how fair was it to decide to tax EPF? Why leave out the investing modes of the rich and decide to tax the middle class EPF?

f) Further, it needs to be realised that different people have different needs. As Jaitley said in the Lok Sabha today: “”Employees should have the choice of where to invest. Theoretically such freedom is desirable, but it is important the government to achieve policy objective by instrumentality of taxation. In the present form, the policy objective is not to get more revenue but to encourage people to join the pension scheme.”

For that to happen there are so many other things that need to be set right. People use their retirement corpus for various things. They use the money to get their children married, educated and so on. While the government may look at this as something that shouldn’t be done but at times there is no option.

Sometimes emergency medical costs are also met out of withdrawing out of the corpus accumulated by investing in the EPF. In a country where there is almost no insurance for the old, how fair is to deny them access to the EPF corpus by deciding to tax it?

What all these points clearly tell us is that the Modi government clearly introduced the idea of taxing the EPF corpus in a hurry. There is clearly more thinking needed on it. Also, several things need to change before such a tax is introduced. And these changes are not going to happen any time soon.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on March 8, 2016

Why EPF Tax is a Bad Idea

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

The finance minister Arun Jaitley wants to tax the corpus accumulated through investments made in the Employees’ Provident Fund(EPF).

As per what he proposed in his third budget speech last week, only 40% of the corpus accumulated by contributions made into the EPF after April 1, 2016, will be tax free. The remaining 60%, if withdrawn, will be taxable. If the remaining 60% is invested in annuities, the entire accumulate corpus will be tax free. The income from annuities will be taxable.

This is a bad idea at multiple levels.

a) The change applies only to those in the private sector earning more than Rs 15,000 per month. As the ministry of finance clarified on this: “The idea behind this mechanism is to encourage people to invest in pension products rather than withdraw and use the entire Corpus after retirement.” So this doesn’t apply to those earning less than Rs 15,000 per month. Why are these people not being encouraged to invest in annuities and not squander away what they have saved for their years in retirement?

Also, if you are working for the government, the entire corpus you accumulate through the General Provident Fund (GPF) or any other recognised provident fund, remains tax free. If you are working for a government owned company like Coal India and investing in the Coal Mines Provident Fund, the entire corpus on maturity remains tax free.

The question is why is a distinction being made on the basis of the employer and not the total amount of corpus that has been accumulated? This is basically an inequitable decision, where those in government are simply trying to protect their retirement savings from being taxed.

b) 100% of the accumulated corpus can be tax free, if the private sector employee uses 60% of the accumulated corpus to buy annuities. This is nothing but a conspiracy to benefit insurance companies. Annuities remain one of the worst forms of investing in India. The returns typically are in the range of 5-7% before tax. Savings accounts, of a few banks pay as well, if not more than that.

As Debashis Basu writes in the Business Standard: “Annuities are a simple information and access arbitrage enjoyed by insurance companies to rip off senior citizens. Insurers buy long-dated governments securities at eight plus per cent and hand down five-seven per cent pretax return to the annuity buyers, keeping the profits.”

So why are we forcing people to buy annuities, if there are better forms of investment available? As I said earlier, it’s nothing but a conspiracy to benefit insurance companies. At the same time all the money going into annuities will ultimately end up in government bonds, which will benefit the government.

c) The idea is to move EPF and other recognised provident funds from EEE (Exempt, Exempt, Exempt) to EET (Exempt, Exempt, Tax). Up until now, many tax saving investments like EPF have come under the EEE regime. The investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax and the final corpus is also exempt from tax.

Under EET (Exempt, Exempt, Tax), the investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax, but the final corpus is taxed. Hence, under EET, the payment of tax is only postponed.

The idea to move from EEE to EET was a part of the Direct Taxes Code(DTC) when it was first introduced in August 2009. The DTC was supposed to replace the current Income Tax Act (1961). The DTC came with other changes as well. Take the case of the tax slabs. The tax slabs were as follows:

The current tax slabs are nowhere these slabs that had been proposed. The tax rate of 10% applies for taxable income between Rs 2.5 lakh and Rs 5 lakh. The tax rate of 20% applies for taxable income between Rs 5 lakh and Rs 10 lakh. And a tax rate of 30% applies for taxable income greater than that.

Given the fact that the entire idea behind the DTC was to simplify the income tax system, it was never implemented. It would have hit people who make a living out of complicated tax laws, very hard.

d) The other big problem with the proposal to tax EPF is that it will tax the entire corpus including the principal. Further, it will not take into inflation into account. Let’s understand this in a little more detail.

Let’s say you invested in real estate in 2005 and you sold it ten years later in 2015. You need to pay a tax on the capital gains at the rate of 20%. While calculating the gains inflation is taken into account. This means that if you had bought real estate, for let’s say Rs 20 lakh, while calculating the gains this amount of Rs 20 lakh will be adjusted for inflation.

If the inflation during the period was 7% per year, then the inflation indexed amount will be Rs 39.34 lakh (Rs 20 lakh x (1.07)^10). This will be the inflation indexed purchase price. If the real estate was sold for Rs 80 lakh, then the capital gains on which tax will have to be paid will amount to Rs 40.56 lakh (Rs 80 lakh minus Rs 39.34 lakh, the inflation indexed amount). On this a 20% tax, which amounts to Rs 8.13 lakh will have to be paid. This is referred to as indexation benefit.
Other deductions which take into account the cost of maintenance of the real estate are also allowed. Further, as mentioned earlier, the principal amount is also not taxed.

As Dhirendra Kumar writes on valueresearchonline.com: “EPF returns are barely above inflation rates. To disallow indexation for inflation is a grave injustice. This is morally and principally wrong. Moreover, because this tax will be on bulk withdrawals, it will push even low-income savers into the 30 per cent tax bracket for that year. This is unconscionable.”

Also, it needs to be pointed out that long-term capital gain on stocks (i.e. stocks sold after one year of purchase) continues to remain zero. So is true for long term capital gains on equity mutual funds. The corpus accumulated through insurance policies also continues to remain tax free.

But the government in its wisdom has decided to tax the total amount of money accumulated through investing in EPF. This proposal is wrong at multiple levels and its time, the government got rid of it.

The column originally appeared on Vivek Kaul’s Diary on March 8, 2016