Provident fund faces exit tax

Fund board suggests tax on withdrawals above Rs 20,000.

High salary earners may have to pay tax when they withdraw their provident fund deposits. The Employees' Provident Fund Organisation (EPFO) has recommended to the finance ministry to tax such withdrawals beyond a threshold.

The proposal, if implemented, will discourage high salary earners in the private sector from parking their surplus funds with the EPFO as a tax-free investment option.

Employees have to compulsorily put 12 per cent of their monthly salary of up to Rs 6,500 in the EPFO. Contributions above that are optional but earn the same rate of interest.

Skewed corpus
Balance in EPF (in Rs)	Per cent of  contributors	Per cent of  EPF corpus
< 20,000	84.58	16.98
20,000-50,000	8.30	21.52
50,000-99,999	3.68	16.67
1 lakh-2 lakh	2.28	20.25
2 lakh-3 lakh	0.67	10.54
3 lakh-4 lakh	0.24	5.23
4 lakh-5 lakh	0.10	2.83
5 lakh-6 lakh	0.10	4.29
6 lakh-7 lakh	0.10	1.45
7 lakh-8 lakh	0.10	0.31
(On March 31, 2004)

According to government sources, the tax may be levied on the interest income only. This would be consistent with the tax treatment of other pension funds being considered by the government, they said.

The sources said such a tax would also lower the effective rate of interest being earned by high value depositors, from the current 9.5 per cent.

The finance ministry has asked the EPFO to lower the rate of interest on its deposits and bring it in line with other small savings instruments.

At present, there is no tax at any stage on deposits, earnings or withdrawals from the fund. Allied with the high interest rate of 9.5 per cent on the deposits, investors have found the tax-free combination highly lucrative, boosting the EPFO corpus to Rs 1,28,036 crore on March 31, 2004.

This has the potential to create a major asset-liability mismatch for the EPFO, as its investments do not earn the 9 per cent return that it has promised. Almost 80 per cent of the EPF corpus is parked in the special deposit scheme of the government, which earns only 8 per cent.

According to the EPFO, more than 84 per cent of its contributors have an average balance of less than Rs 20,000 in their account. Their contribution, however, makes up for only 17 per cent of the fund's corpus. The proposal would, thus, be equitable, the sources said, since low income earners would continue to enjoy the tax benefits.

The trade unions on the Central Board of Trustees (CBT) of the EPFO are also in favour of this proposal. They feel this will enhance the position of the EPFO as a social security net for the working classes.