Is Interest Earned By Employee Provident Fund Taxable?

Union Budget 2021 has proposed to impose income tax on interest earned by an employee/person on his/her contribution in excess of Rs 2.5 lakh in a financial year to a provident fund. 

On a plain reading of the budget documents, it appears that tax will apply to the interest earned on contributions made to Employees' Provident Fund (EPF), Voluntary Provident Fund (VPF) as well as Public Provident Fund (PPF). 

However, tax experts have clarified that there are separate limits for EPF/VPF and PPF. Which means contributions to PPF and EPF/VPF will not be aggregated for the purpose of calculating the Rs 2.5 lakh limit.

Detailed Explanation

Presently in EPF contribution consists of 12% of the basic salary from Employees account and additional 12% of the basic salary from Employers account. In total 24% of the basic salary will be added in EPF account every month.

But Employees have an option to increase their contribution from 12% to 100% and the additional contribution also earns the same interest rate as decided by the employee provident fund organization. Hence the Government has imposed income tax on the interest earned by the contribution Which is above 2.5 Lac/year.

For Example Let us say Ram invest 2.4 Lac/year in his EPF account (Both EPF and VPF combined), and if he earns 20,400 rs interest (Considering 8.5% return on SI basis) then ram need not to pay any tax on this interest earned because his investment in EPF is below 2.5 Lac/year.

Now,  let us say Sham invest 5 lac/year in his EPF account (Both EPF and VPF combined), and if he earns 42,500 rs interest (Considering 8.5% return on SI basis), Now Sham have to pay income tax on 21,500 rs (as per his income tax slab) because this interest amount is being earned by investing extra 2.5 lac/year over the maximum limit of 2.5 lac/year.

This rule mainly affects the earnings of the rich people whose salary is above 21 Lac/year. This new rule will be applicable from 1st April 2021 once this is passed by the parliament.