How New Income Tax Rules Affect Interest on EPF Savings

Earlier in the month of March, the Employees’ Provident Fund Organization (EPFO) announced that the interest rate on Employee Provident Fund (EPF) accumulations in the members’ accounts would be 8.1% for fiscal year 2022-23. The interest on EPF for FY 2021-22 was fixed at 8.5% which means the interest rate has been cut by 0.4% and it is the lowest interest rate fixed by the EPFO since 1977. The interest on EPF was completely tax free for provident fund contributors until changes were introduced in the 2021 Budget which came into effect on 1st April 2021 according to which interest on EPF contribution beyond a specified threshold will be taxable.

To make calculations easy, separate accounts within the provident fund shall be maintained from 2021-22 onwards for taxable & non-taxable contributions made by a person. In other words, the provident fund office or the employee PF trust, will maintain two accounts for this purpose: One with contribution within the threshold and the other (second) for contribution over the threshold.

How New Income Tax Rules Will Affect EPF Interest:

  • According to the new rules introduced by the Income Tax Department, interest credited to the provident fund account of an employee will be tax free for contribution of ₹2.5 lakhs every year & interest on employee’s contribution exceeding ₹2.5 lakhs shall be taxed to the employee every year. If the employer doesn’t contribute to the provident fund of the employee, then the threshold applicable will be up to ₹5 lakh of employee’s contribution.
  • The ₹5 lakh threshold will cover nearly 93% of EPFO subscribers who will continue to receive tax-free interest on their contribution according to the interest rate fixed by the EPFO
  • Generally, the employer contributes 12% of the basic salary plus dearness allowance to the EPF account of the employee and another 12% is deducted from the employee’s pay as employee’s contribution. 8.33% of the 12% contribution made by the employer goes towards the Employees’ Pension Scheme (EPS) which earns zero interest.
  • The interest on excess contribution will be taxable and not the excess contribution itself. The excess contribution will be made by the employee from their salary which is already taxed and thus is not taxable again.
  • Balance standing to the credit of an employee as on 31st March 2021 is concerned, interest on this non-taxable account will continue to remain tax free.
  • Only the interest on the second/taxable account will be taxed every year.
  • For the second/taxable account, it is not only for the year of contribution but also for all the subsequent years that the interest will become taxable.

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