In the Union Budget 2021-22 presented on Monday, Finance Minister Nirmala Sitharaman proposed to do away with the tax exemption for interest income earned on provident fund contributions above Rs 2.5 lakh per year. Once the budget is approved by the Parliament, the provision will come into effect from 1 April 2021.
This was done to stop giving tax-free interest income to high-income earners. Currently, the Income Tax Act, 1961, provides for an exemption to any payment from a provident fund and to the accumulated balance due and becoming payable to an employee. There have been instances where some employees are contributing huge amounts to these funds and getting tax exemption.
The contribution limit for tax-free interest income has now been set for an annual contribution of Rs 250,000 which will be applicable only for the contribution made on or after April 1, 2021. The exact formula and way of tax taxes will be given by the government soon.
The restriction will largely impact Voluntary Provident Fund (VPF) contributions, which gives fixed interest. Many high earners use the VPF route to save more. An employee’s contribution to the Employee Provident Fund (EPF) account also earns a tax break under Section 80C of up to Rs 1.5 lakh. This amounts to 12% of salary that is deducted by an employer and deposited in the EPF or other recognised provident funds.
In the previous year’s budget, the deductions available on employer contributions to retirement benefit funds (including PFs) was restricted to Rs 7.5 lakh.