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Income tax on Provident Fund

Income tax on Provident Fund (Employee and employer contributions to) is subject to specific tax rules, which vary by fund type

  • 3,133 Views | Updated on: Aug 02, 2024

Employee and employer contributions to a PF (Provident Fund) are subject to specific tax rules determining whether they are exempt or included in taxable income. PF is a long-term savings scheme that offers attractive interest rates and tax benefits.

Income tax on Provident Fund and benefits on these schemes vary based on the type of provident fund, such as the Statutory Provident Fund, Recognized Provident Fund, Unrecognized Provident Fund, and Public Provident Fund.

Tax Treatment of Provident Fund

Tax treatment of a provident fund refers to how your contributions and earnings in a provident fund (PF) account are taxed by the government.

Whether the money you put into your PF (employee contribution) and the money your employer puts in (employer contribution) are exempt from tax or count as part of your taxable income. Let us take a look at provident fund taxation under different criteria:

Criteria

Statutory Provident Fund

Recognized Provident Fund

Unrecognized Provident Fund

Public Provident Fund

Employer’s contribution

Exempt from tax

Exempt up to 12% of salary

Exempt from tax

The employer does not contribute to such fund

Employee’s contribution eligible for deduction u/s 80C

Yes

Yes

No

Yes

Interest credited to the said fund

Exempt from tax

Exempt from tax if the interest rate is up to the prevalent rate. Interest over the prevalent rate is charged to tax.

Exempt from tax

Exempt from tax

The amount received at the time of termination of service

Exempt from tax

If certain conditions are satisfied, then the lump sum amount is exempt from tax

If certain conditions are satisfied, then the lump sum amount is exempt from tax

Exempt from tax

What is the Old Tax Provision for Income Tax on PF Interest?

The old tax provision for income tax on Provident Fund (PF) interest offered employees significantly more benefits than the current system. Interest earned on PF contributions was completely tax-free, regardless of the contribution amount, allowing employees to maximize their savings. Employee contributions were eligible for a tax deduction under Section 80C, up to a limit of ₹1.5 lakh per financial year, further enhancing the tax benefits.

Employer contributions were also favorably treated; contributions up to 12% of an employee’s salary were exempt from tax, while contributions exceeding this threshold were taxable according to the employee’s income slab. Importantly, there was no cap on the amount of tax-free interest earned on PF contributions, and while employer contributions above 12% of the salary were taxable, the interest accrued on these contributions remained tax-free.

What is the New Tax Provision for Income Tax on PF Interest?

The new tax provision for income tax on PF interest, introduced in the Budget 2021, applies to contributions made from the financial year 2021-22 onwards. Previously, all interest earned on your PF contributions was tax-free. Only the interest on contributions up to a certain limit escapes tax. This limit is ₹2.5 lakh per financial year for most employees and ₹5 lakh for government employees. Any interest earned on contributions exceeding this limit will be taxable according to your income tax slab.

How to Calculate the Taxable and Non-taxable Shares of EPF Interest?

Calculating the taxable and non-taxable portions of your EPF interest requires considering your annual employee contribution limit and the interest rate.

It is necessary to maintain two separate accounts for each financial year starting from FY 2021-22: one for the non-taxable contributions (up to ₹2.5 lakh or ₹5 lakhs) and another for the taxable contributions (above ₹2.5 lakh or ₹5 lakhs). Interest accrued on each account will be calculated individually, with the interest on the taxable account being added to the employee’s income. This taxable interest is considered “income from other sources” and will be subject to TDS if it exceeds ₹5,000 in a year.

For example:

Let’s say your total annual employee contribution to the EPF was ₹3 lakh, the interest rate was 8%, and the applicable contribution limit is ₹2.5 lakh.

Non-taxable interest = ₹2.5 lakh * 8% = ₹20,000

Taxable interest = (₹3 lakh - ₹ 2.5 lakh) * 8% = ₹40,000

(Since your contribution exceeded the limit)

Therefore, ₹20,000 EPF interest is non-taxable, and ₹40,000 is taxable as per your income tax slab.

Conditions of TDS on EPF Withdrawal

Two main conditions determine whether Tax Deducted at Source (TDS) applies when you withdraw money from your Employee Provident Fund (EPF) account in India:

Completion of Service

TDS might apply to your withdrawal if you have not completed 5 years of continuous service. There’s no TDS deduction if you’ve been employed for 5 years or more, even if the withdrawal amount is high.

Amount of withdrawal

Generally, withdrawals below ₹50,000 are not subject to TDS, irrespective of your service tenure. For withdrawals exceeding ₹50,000, TDS kicks in if you haven’t completed 5 years of service.

Key Takeaways

  • Employee contributions are eligible for Section 80C deductions; however, interest and final income tax on PF withdrawal are tax-free.
  • As per the old regime, interest on PF contributions was completely tax-free, and they were eligible for tax deductions under Section 80C up to ₹1.5 lakh.
  • For contributions from FY 2021-22 onwards, only interest on contributions up to ₹2.5 lakh per year (₹5 lakhs for government employees) is tax-free.
  • Interest on EPF is calculated individually is added to the employee’s income and is subject to TDS if it exceeds ₹5,000 annually.

Conclusion

Understanding the tax treatment of your Provident Fund (PF) contributions and interest is crucial for maximizing your savings and minimizing tax liability. The old tax provisions offered more favorable conditions, with tax-free interest on contributions and higher limits for tax exemptions on employer contributions.

Awareness of TDS conditions on EPF withdrawals ensures compliance and helps avoid unexpected income tax deductions. Staying informed about these aspects enables employees to optimize their PF benefits and plan their financial future more efficiently.

FAQs on Income Tax for Provident Fund

1

Is the employer’s contribution to PF taxable?

The employer’s contribution to the Provident Fund (PF) is not taxable up to 12% of the employee’s salary. Contributions above this limit are added to the employee’s income and taxed accordingly.

2

What is the interest rate on PF, and is it taxable?

The government determines the interest rate on the Provident Fund (PF) annually. The interest earned is tax-free, provided the employee completes five continuous years of service.

3

Are partial withdrawals from PF taxable?

Partial withdrawals from PF are tax-free if they meet specific conditions, such as for medical emergencies, home purchase, or education, and if the employee has completed five years of continuous service.

4

Can NRIs (Non-Resident Indians) contribute to the Provident Fund, and what are the tax implications?

NRIs cannot contribute to the Employees’ Provident Fund (EPF). However, they can withdraw their accumulated balance, which may be subject to tax based on the withdrawal conditions and the period of contribution.

5

What is the tax treatment for PF withdrawal in case of the death of the employee?

PF withdrawal in the event of an employee’s death is tax-free. The nominee or legal heir can claim the accumulated PF balance without any tax liability.

6

How does one claim tax exemption on EPF withdrawals?

To claim tax exemption on EPF withdrawals, ensure you meet the conditions of completing five continuous years of service. The withdrawal must also be for eligible reasons such as retirement, medical emergencies, or specific purchases.

7

What is the difference between employee PF and employer PF contributions?

Employee PF contribution is deducted from the employee’s salary, while the employer’s PF contribution is made by the employer. Together, both contributions form the total Provident Fund balance of the employee.

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The content has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Further customer is the advised to go through the sales brochure before conducting any sale. Above illustrations are only for understanding, it is not directly or indirectly related to the performance of any product or plans of Kotak Life.