Why EPF Tax is a Bad Idea

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

The finance minister Arun Jaitley wants to tax the corpus accumulated through investments made in the Employees’ Provident Fund(EPF).

As per what he proposed in his third budget speech last week, only 40% of the corpus accumulated by contributions made into the EPF after April 1, 2016, will be tax free. The remaining 60%, if withdrawn, will be taxable. If the remaining 60% is invested in annuities, the entire accumulate corpus will be tax free. The income from annuities will be taxable.

This is a bad idea at multiple levels.

a) The change applies only to those in the private sector earning more than Rs 15,000 per month. As the ministry of finance clarified on this: “The idea behind this mechanism is to encourage people to invest in pension products rather than withdraw and use the entire Corpus after retirement.” So this doesn’t apply to those earning less than Rs 15,000 per month. Why are these people not being encouraged to invest in annuities and not squander away what they have saved for their years in retirement?

Also, if you are working for the government, the entire corpus you accumulate through the General Provident Fund (GPF) or any other recognised provident fund, remains tax free. If you are working for a government owned company like Coal India and investing in the Coal Mines Provident Fund, the entire corpus on maturity remains tax free.

The question is why is a distinction being made on the basis of the employer and not the total amount of corpus that has been accumulated? This is basically an inequitable decision, where those in government are simply trying to protect their retirement savings from being taxed.

b) 100% of the accumulated corpus can be tax free, if the private sector employee uses 60% of the accumulated corpus to buy annuities. This is nothing but a conspiracy to benefit insurance companies. Annuities remain one of the worst forms of investing in India. The returns typically are in the range of 5-7% before tax. Savings accounts, of a few banks pay as well, if not more than that.

As Debashis Basu writes in the Business Standard: “Annuities are a simple information and access arbitrage enjoyed by insurance companies to rip off senior citizens. Insurers buy long-dated governments securities at eight plus per cent and hand down five-seven per cent pretax return to the annuity buyers, keeping the profits.”

So why are we forcing people to buy annuities, if there are better forms of investment available? As I said earlier, it’s nothing but a conspiracy to benefit insurance companies. At the same time all the money going into annuities will ultimately end up in government bonds, which will benefit the government.

c) The idea is to move EPF and other recognised provident funds from EEE (Exempt, Exempt, Exempt) to EET (Exempt, Exempt, Tax). Up until now, many tax saving investments like EPF have come under the EEE regime. The investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax and the final corpus is also exempt from tax.

Under EET (Exempt, Exempt, Tax), the investment made can be deducted from taxable income and hence is exempt from tax, the interest earned on the investment is exempt from tax, but the final corpus is taxed. Hence, under EET, the payment of tax is only postponed.

The idea to move from EEE to EET was a part of the Direct Taxes Code(DTC) when it was first introduced in August 2009. The DTC was supposed to replace the current Income Tax Act (1961). The DTC came with other changes as well. Take the case of the tax slabs. The tax slabs were as follows:

The current tax slabs are nowhere these slabs that had been proposed. The tax rate of 10% applies for taxable income between Rs 2.5 lakh and Rs 5 lakh. The tax rate of 20% applies for taxable income between Rs 5 lakh and Rs 10 lakh. And a tax rate of 30% applies for taxable income greater than that.

Given the fact that the entire idea behind the DTC was to simplify the income tax system, it was never implemented. It would have hit people who make a living out of complicated tax laws, very hard.

d) The other big problem with the proposal to tax EPF is that it will tax the entire corpus including the principal. Further, it will not take into inflation into account. Let’s understand this in a little more detail.

Let’s say you invested in real estate in 2005 and you sold it ten years later in 2015. You need to pay a tax on the capital gains at the rate of 20%. While calculating the gains inflation is taken into account. This means that if you had bought real estate, for let’s say Rs 20 lakh, while calculating the gains this amount of Rs 20 lakh will be adjusted for inflation.

If the inflation during the period was 7% per year, then the inflation indexed amount will be Rs 39.34 lakh (Rs 20 lakh x (1.07)^10). This will be the inflation indexed purchase price. If the real estate was sold for Rs 80 lakh, then the capital gains on which tax will have to be paid will amount to Rs 40.56 lakh (Rs 80 lakh minus Rs 39.34 lakh, the inflation indexed amount). On this a 20% tax, which amounts to Rs 8.13 lakh will have to be paid. This is referred to as indexation benefit.
Other deductions which take into account the cost of maintenance of the real estate are also allowed. Further, as mentioned earlier, the principal amount is also not taxed.

As Dhirendra Kumar writes on valueresearchonline.com: “EPF returns are barely above inflation rates. To disallow indexation for inflation is a grave injustice. This is morally and principally wrong. Moreover, because this tax will be on bulk withdrawals, it will push even low-income savers into the 30 per cent tax bracket for that year. This is unconscionable.”

Also, it needs to be pointed out that long-term capital gain on stocks (i.e. stocks sold after one year of purchase) continues to remain zero. So is true for long term capital gains on equity mutual funds. The corpus accumulated through insurance policies also continues to remain tax free.

But the government in its wisdom has decided to tax the total amount of money accumulated through investing in EPF. This proposal is wrong at multiple levels and its time, the government got rid of it.

The column originally appeared on Vivek Kaul’s Diary on March 8, 2016

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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