Taxing EPF to promote annuity culture a bad idea
Given that the government has been keen on promoting the New Pension Scheme (NPS) for a long time—as finance minister Arun Jaitley said in his budget last year, the EPFO is supposed to have hostages, not clients—it was only natural that it would address its unfair tax treatment. While withdrawals from the EPFO at retirement are tax-free, those from the NPS are not. The problem is that in its hurry to fix things, the government went and messed it up and, as its press release on Tuesday indicated, it looks like it may even have to withdraw the proposal completely. In the budget, while saying that 40% of the corpus from the NPS could be withdrawn without paying a tax on it, Jaitley added the same would apply to the EPFO—that is, while 40% of the withdrawals from the EPFO would not be taxed, the rest would. The idea was to equate it with NPS where 60% of the corpus on retirement has to compulsorily be converted into an annuity. When this set off howls of protest, the revenue secretary clarified at a post-budget press conference on Monday that this applied just to the new accruals after April 1, not to the investments already made and the interest earned on them—this, of course, was only fair and is what the budget also said, though not so clearly; anything else would be tantamount to a retrospective amendment since people investing in EPFO do so knowing full well that the investments are tax-free. On Tuesday, the government put out a press release saying that if the 60% of the funds withdrawn from the EPFO were put in annuities, they would not be taxable—it also reiterated the budget decision to put a cap of R1,50,000 on the annual contribution from the employer as opposed to the situation today where there is no cap.
What is being planned is unfair at various levels. For one, the annuities on offer today offer a 6-7% return, so why force people to invest in products with lower returns—more so since, at the time when they are contributing to the corpus, the returns being offered are much higher; indeed, if the government was keen on promoting NPS, it needed to fix this anomaly of compulsory annuity investments. Two, if the attempt was to prevent the better off from enjoying the higher interest rates offered by the EPFO—that’s not even true, though, considering NPS returns are higher—as is being argued now, why not just ban them from the scheme? While a cap of R1.5 lakh per year is being put on the employer’s contribution, the employee is still free to invest as much as s/he wants—an interesting aside is that since the bulk of payments into the EPFO come from the well-heeled, its corpus will shrink considerably as investors will then prefer to invest in other instruments like fixed deposits or mutual funds. Also, by charging a tax on 60% of the EPFO corpus on withdrawal, the pensioner will end up paying an amount that is higher than the extra interest supposedly earned. That is why one of the proposals before Jaitley is to levy the tax only on the interest component since, in any case, contrary to what the government says, anyone investing over R1.5 lakh per year in the EPFO (that is the Section 80C benefit) ends up paying tax on the additional amount even today—when a tax has already been paid on this, why should 60% of this be taxed all over again? Which is why, when such big changes are being made, it is always a good idea to put things out in the open for a public discussion—apart from not taking stakeholders by surprise, the government will also benefit from the consultation.