To curb wealthy people from parking excess money in Provident Funds (PFs) to earn higher tax-free interest, Finance Minister Nirmala Sitharaman has announced in the Union Budget 2021-22 that PF contributions over Rs 2.5 lakh in a financial year will be taxable from the next financial year.
“The budget 2021 has placed a strong emphasis on infrastructure development be it social, physical, or financial infrastructure to re-energise the Covid-hit economy. On the direct tax side, changes pertain to simplification of REITS & InVITS and compliance related announcements,” S Ravi, Former Chairman of Bombay Stock Exchange, Founder & Managing Partner a of Ravi Rajan & Co.
“However restrictions have been imposed on tax exemption for the interest earned on the employees’ contribution to various provident funds. Interest earned on employee’s contribution above Rs 2.5 lakh a year will now be taxed as ordinary income. The rationale for introducing the measure is to curtail the practice of parking large sums in the PF account to seek dual benefit of tax exemption and high interest rate,” he added.
According to Ravi, tax on interest PF contribution over Rs 2.5 lakh would not affect majority of PF subscribers.
“The Employees’ Provident Fund Organisation (EPFO) is the world’s largest social security organisations, which maintains close to 193.4 million accounts and considering only a small section make an annual contribution upwards of Rs 2.5 lakh, the measure curbs misuse by them,” he said.
However, with the interest on excess contributions to be added to their income, wealthy PF contributors would now shift their investments to other alternative options to reduce tax liabilities.
“This measure will act as an inhibitor and drive investors to other viable investment opportunities,” said Ravi.
Here are some other viable investment options:
National Pension System (NPS)
With the commutation part on maturity now tax free, NPS is a good alternative for pension seekers.
The wide investment options also make it suitable for both aggressive and conservative investors.
“NPS is one such option, which provides a better interest rate that PF and tax efficient as well,” said Ravi.
Equity Linked Saving Scheme (ELSS)
ELSS is a good tax-saving investment option especially for equity investors. On redemption, 10 per cent capital gain tax is levied on gain over Rs 1 lakh in a financial year.
“ELSS – that offers dual advantage of capital appreciation as well as tax saving – has lower lock-in period (3 years) than PF & NPS,” said Ravi.
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