CA Gautam Baid has meticulously examined the proposed amendment to section 10(12) of the Income-tax Act, 1961 by the Finance Bill 2016 to tax the accumulated balance received by an employee from an Employee Provident Fund and explained its implications
Before the proposed amendment there is no ambiguity about the taxability of the amount received by the assessee from the recognised provident fund. Proposed amendment leads not only agitation from the stakeholders but also leads to ambiguity about the interpretation of provision and amount which may be taxed in the hands of employee out of total amount received by employee from REPF. This article explained that there is no reason to worry about the proposed amendment as there is no major impact on the taxing income due to such change.
Relevant statutory provisions are as under:
Income Tax Act, 1961 Section 2(38)
“recognised provident fund” means a provident fund which has been and continues to be recognised by the Principal Chief Commissioner or Chief Commissioner or Commissioner in accordance with the rules contained in Part A of the Fourth Schedule, and includes a provident fund established under a scheme framed under the Employees’ Provident Funds Act, 1952 (19 of 1952)
Section 7 Income Deemed to be Received
The following incomes shall be deemed to be received in the previous year:–
(i) the annual accretion in the previous year to the balance at the credit of an employee participating in a recognised provided fund, to the extent provided in Rule 6 of Part A of the Fourth Schedule;
(ii) the transferred balance in a recognised provident fund, to the extent provided in sub-rule (4) of Rule II of Part A of the Fourth Schedule.
(iii) the contribution made, by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme referred to in section 80CCD.
Section 10 After proposed amendment
In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included –
(12) the accumulated balance due and becoming payable to an employee participating in a recognised provident fund, to the extent provided in rule 8 of Part A of the Fourth Schedule
‘Provided that nothing contained in this clause shall apply in respect of any amount of accumulated balance, attributable to any contributions made on or after the 1st day of April, 2016 by an employee other than an excluded employee, exceeding forty per cent. of such accumulated balance due and payable in accordance with provisions of rule 8 of Part A of the Fourth Schedule.
Explanation.—For the purposes of this clause, the term “excluded employee” means an employee whose monthly salary does not exceed such amount, as may be prescribed;’;
For the purposes of sections 15 and 16 and of this section,–
(1) “salary” includes–
(vi) the annual accretion to the balance at the credit of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth Schedule; and
THE FOURTH SCHEDULE
PART A – RECOGNISED PROVIDENT FUND
Rule 2 definition
In this Part, unless the context otherwise requires, —
(c) “contribution” means any sum credited by or on behalf of any employee out of his salary, or by an employer out of his own moneys to the individual account of an employee but does not include any sum credited as interest;
(e) “annual accretion” in relation to the balance to the credit of an employee, means the increase to such balance in any year, arising from contributions and interest;
(f) “accumulated balance due to an employee” means the balance to his credit, or such portion thereof as may be claimable by him under the regulations of the fund, on the day he ceases to be an employee of the employer maintaining the fund.
Rule 6: Employer’s annual contributions, when deemed to be income received by employee
That portion of the annual accretion in any previous year to the balance at the credit of an employee participating in a recognised provident fund as consists of—
(a) contributions made by the employer in excess of ten per cent, of the salary of the employee, and
(b) interest credited on the balance to the credit of the employee in so far as it exceeds one-third of the salary of the employee or is allowed at a rate exceeding such rate as may be fixed by the Central Government in this behalf by notification in the official Gazette,
shall be deemed to have been received by the employee in that previous year and shall be included in his total income for that previous year, and shall be liable to income-tax 1[***].
Rule 7: Exemption for employee’s contributions
An employee participating in a recognised provident fund shall, in respect of his own contributions to his individual account in the fund in the previous year, be entitled to a deduction in the computation of his total income of an amount determined in accordance with section 80C.
Rule 8: Exclusion from total income of accumulated balance:
The accumulated balance due and becoming payable to an employee participating in a recognised provident fund shall be excluded from the computation of his total income—
(i) if he has rendered continuous service with his employer for a period of five years or more, or
(ii) if, though he has not rendered such continuous service,
the service has been terminated by reason of the employee’s ill-health, or by the contraction or discontinuance of the employer’s business or other cause beyond the control of the employee.
The proposed amendment is in section 10 and therefore before reaching any conclusion we must understand the provisions of section 10. Section 10 deals with various exceptions where despite other provisions of the Income Tax Act income will not be assessable in the hands of assessee (recipient). One thing we must bear in mind that relevancy of the exception to assessable income will relevant only and only if the particular item is taxed as income under the provisions of income tax, if such exception is not there.
If an item which is not at all taxable under the law of Income Tax if stated under section 10, same cannot be taxable on the removal of such exception. One example where exception under section 10 is provided despite the item is not assessable under Income Tax Provisions is given in sub section (1) which is Agricultural Income. By virtue of constitutional provisions Central Govt. cannot impose tax on ‘Agricultural Income’ and therefore whether there is specific exception under section 10 or not is not important and such exception is only for clarification. Likewise the item which cannot be considered as income under the provisions of income tax, reference of such item in section 10 cannot be interpreted as that such item is income taxable under the income tax act and exempted only because of exception u/s 10. If any item stated under the provisions of section 10 which is not considered as income such item remain beyond the scope of income tax even if such clarificatory exception removed.
Therefore before presuming that because of restriction imposed by proposing proviso to sub section (12) of section 10, all receipt from REPF in excess of 40% of the accumulated balance is taxable, we must examine the nature of receipt from REPF and if such receipt can be considered as income as per income tax law, than only question of taxation of the same arises and for exemption of such receipt from tax there should be specific exception. If receipt cannot be considered as income same cannot be taxed merely because there is no specific provision for exemption under section 10 or any other provision of income tax law.
To examine nature of receipt for the purpose of taxation under income tax law, we found that Recognised EPF withdrawal has four components:
Interest accrued on Employee’s Contribution
Interest accrued on Employer’s Contribution
Receipt of the principal amount of employee’s contribution cannot be treated as income of the assessee as the same is only encashment of the investment made. Merely because of deduction u/s 80C allowed for contribution [Rule 7 of PART A of the Fourth Schedule] same cannot be taxed at the time of withdrawal because of the present proposed amendment in clause (12) of section 10. Before amendment also such receipt is not taxable because it is not income at all and not because of clause (12) of section 10. Such sum cannot be taxed in the hands of employee even if (i) clause (12) of section 10 entirely deleted or (ii) Rule 8 of PART A of the Fourth Schedule not at all exists. It may be pertinent to mention hear that the despite the heading of the Rule 7 as ‘Exemption for employee’s contribution’ there is nothing stated about exemption of employee’s contribution in the body of rule which is “An employee participating in a recognised provident fund shall, in respect of his own contributions to his individual account in the fund in the previous year, be entitled to a deduction in the computation of his total income of an amount determined in accordance with section 80C.”
Receipt of the principal amount of employer’s contribution cannot be treated as income of the assessee at the time of encashment of the same if (i) such contribution has no element of income at the time of such contribution or (ii) such contribution has element of income at the time of contribution and exemption is provided for exclusion of such contribution from income on the condition that such sum will be taxable at the time of payment of such sum to the employee.
Considering provisions of Section 7, Section 17 and Rule 6, it can be concluded that employer’s contribution and interest accrued up to certain extent not at all income of the assessee and such provisions are not subject to any further condition. Rule 8 cannot be interpreted as a condition for applicability to Rule 6 or any exception to Rule 6, condition laid under Rule 8 are with reference to period of employment. Further to this employer’s contribution and interest accrued in excess of limit laid under Rule 6 is deemed to be received in the year in which contribution made by employer and interest accrued on the credit balance of REPF and required to be taxed year on year basis.
Similarly interest accrued on the employee as well as employer‘s contribution when not considered as income of the employee in the year in which same accrued as per Rule 6 without any condition imposed for such exclusion, same cannot be considered as income in the year in which same was received by the Employee without amending Rule 6.
Note: Had the proviso inserted to section 10(12) same inserted to Rule 6, the proposed intention can be achieved without any ambiguity and agitation on the matter.
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