Why EPF Tax is a Bad Idea - Vivek Kaul's Diary
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Why EPF Tax is a Bad Idea

Mar 8, 2016


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 The remaining 60%, if withdrawn, will be taxable.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.

  1. 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.

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  3. 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.

  4. 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.

  5. 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.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek 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. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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8 Responses to "Why EPF Tax is a Bad Idea"

S Gopalan

Mar 13, 2016

Why have separate idea of annuities which are nothing but big fraud when it comes to returns? Keep the annuity options simple by linking with SCSS rate which is at present above 9%. Otherwise, NPS will never take off unless the so called intermediaries step in and fool the investors


Sreedhar Krishna Murthy,

Mar 8, 2016

The article covers the taxation policy of EEE and EET very clearly. This is useful. However by the time the article was published the decision of the Finance Minister to roll back the proposal was already known and announced in the Parliament. It is a bit too late.

The article mentions that 60% of the EPF withdrawal would be taxable. This is not fully correct. First 40% of the accumulation would be tax exempt. Out of the balance 60%, if 40% is invested in Annuities, balance 20% would be exempt. Thus 60% would be exempt even if 40% is not invested in annuities.

In India, majority of employees are not covered under pension scheme and many employees spend away the lumpsum retirement benefits from EPF and would be in distress in their hour of need without any periodical income. Therefore, bringing most employees under pension scheme is a better option to ensure their welfare. Investing in Annuity may not be a very attractive from return point of view. However, providing a pension to them is a laudable idea. There may be a case for enhancing the returns by prudent investments. The suggestion to index the returns with reference to inflation is commendable. Govt. should think of very fair and attractive returns and a reasonable amount as pension so that it can ensure a decent living. Taxing the amount withdrawn was meant to dissuade employees from withdrawing the entire amount and spending. However, taxing the entire amount as income of one year works harsher.

Govt. and insurance companies being benefited is incidental and cannot be complained off.

Now the matter is set at rest by Govt.s announcement of roll back.



Mar 8, 2016

Giving a practical illustration, I intend to show how the p.f system itself is highly unfair.
The purchasing power of the money returned at the end of one's service is hardly 10% of the pp of the money deposited. THIS IS THE EFFECT OF INFLATION.
When I joined govt. service in 1956 on a salary of Rs. 350/= p.m. + Rs.30 d.a I could have a full lunch/dinner at Purohits for less than 1/-. I could see a movie at Metro or New Empire in the Balcony at less than 1/-
With the accumulated interest this 1/= will be given to me as 4/= after 35 years
But the corresponding prices would be 40/=
I get only 10p value.
On top of this if this is taxed, this is SADISM AT ITS WORST.
The previous F,M P.Chidambaram, had said INFLATION is the worst form of TAXATION.
An honest govt servant on P.F. when he retires is the POOREST MAN.
Another illustrationIn 1991 a Head of a Department got Rs 7500/= as a monthly salary.
In 2015,the lowest grade staff gets Rs.25,000/= p.m
You have already pushed him (p.f. man)below the poverty line



Mar 8, 2016

Tax on E P F is certainly a bad idea of our Hon'ble FM, as this is the only the corpus in hands with the salaried persons at the time of retirement. Again making of difference in between the Govt Employees and Pvt Sector employees is also setter the confidence of the general people. Law maker must provide justice to the people at par with other.

I appreciate the issues raised by Mr Vivek and the Government must think over it once again before enforcing it.



Mar 8, 2016

Dear sir
NPS is government's own child which did not grow even after exclusive tax exemption of 50,000 under section 80c. It has not been marketed properly. It proves once again that it is very difficult to
market a financial product without intermediaries to majority of financial illiterate masses in our country.FM'S idea is not to encourage the annuities of insurance companies but to promote NPS vigorously. Employees resist the idea of equity investment from EPF contribution but it is not the same in NPS where many investors can choose equity investment option. More money can be mobilized and channeled to equity market. Please understand that the first immediate annuity launched in the nineties by LIC is still giving 12% annuity and the subsequent one is giving 9%. FM says that he wants pensionable population and if it is true he should remove service tax on immediate and deferred pension products. Immediate Annuity policy guarantees 7.5% for life even if the interest rates go down to zero.
Are there safe instruments for elderly people other than immediate annuity and post office scs wherein one can get guaranteed pension and capital guarantee?


Vijay Kumar

Mar 8, 2016

Successive Goverments have been trying to tax EPF & PPF also on EET -the policies making is Driven by Babu's who get Pension which sometimes is more than the last drawn Salary (due to CPI indexation) .In addition they also get CGHS benefits .
Therefore ,their benefits are never curtailed but people working in Private sector who donot have Pension, nor Health Benefits.
Even if the Govt agrees to rollback ,it seems that this is a temporary reprieve



Mar 8, 2016

An excellent article. With the withdrawal of standard deduction, the salaried middle class were hard hit.
After the backlash however the government has withdrawn the proposal.

Like (1)

AB Pereira

Mar 8, 2016

Thanks to all the noise we made, the FM is considering withdrawal of this crazy idea. Thank you Vivek for raising the awareness. In fact, many of the newer taxes in the past were imposed or are continued, due to accepting them with bended backs and not making enough noise by the people. Thats why something like Service Tax was introduced as part of the Finance Act (Budget) in 1994, which has stood the day till today without a separate law being enacted for it! And that is being raised regularly. All because the MPs are so compromised (irrespective of whether in ruling or opposition) and have lost any idea of how to safeguard public interest.
Most astonishingly, lawyers are exempt from STax compliance (and no wonder, whether Chidambaram or Jaitley, our finance ministers, are basically lawyers, along with a large number of past and present ministers and MPs).

Like (1)
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