How EPF withdrawals are taxed
Withdrawal of EPF accumulated balance is not taxable if:
- An employee participating in EPF has rendered continuous service for five or more years;
- Or, if before 5 years, the employee’s service has been discontinued on grounds of ill-health, or by contraction or discontinuance of employer’s business or other causes beyond the control of the employee.
- In other circumstances, the accumulated balance withdrawn within five years of continuous service is considered as taxable income.
During the Covid-19 pandemic, many employees lost their jobs due to business uncertainties. The following illustration brings out the taxability of EPF withdrawal in different cases/ circumstances (all figures in Rs): As Rohan’s employment was terminated by his employer, the EPF balance withdrawn by him will be exempted from tax.
Taxability of EPF withdrawal
As Rashi voluntarily resigned from employment after working for 2 years, her EPF balance withdrawn would be taxable. For withdrawals in excess of Rs 50,000, tax is usually deducted at source. Roshni, who did not withdraw the EPF amount, can map the accumulated balance to the new employer, in case she continues with EPF. Rahul rendered continuous service of more than five years, so his accumulated EPF would not be taxable. However, the interest that has accrued for the period of two years after cessation of employment would be taxable in his hands.
EPF advance during pandemic
The government has allowed members of the EPF scheme to claim ‘non-refundable advance’ from their EPF account to the extent of the basic wages and dearness allowance for three months, or up to 75% of the amount outstanding in the EPF account, whichever is less. This has been a very effective scheme and a timely intervention to address liquidity issues faced by employees during the pandemic. The FAQs released by provident fund authorities have clarified that such withdrawals will not be taxable. However, the corresponding amendment in the Income Tax Act to ensure that the non-refundable advance received is not taxable is still awaited.
Exemption desirable for social security withdrawals
As compared to developed countries, India does not have a strong social security net to protect workers in the event of unemployment. Globally, many countries provide unemployment insurance to employees upon satisfaction of specified conditions. For instance, in the US, those who are unemployed due to no fault of their own are eligible to claim unemployment insurance. In Canada, employment insurance provides benefits to individuals who have lost their jobs and are available for work but cannot find a job. No such social security support is available in India. And, taxation of EPF withdrawals would leave a lower amount in the hands of employees in times of need.
For taxing EPF withdrawals, the limit of five years may be retained. However, exemption from tax may be considered if withdrawals are made before five years to meet certain contingencies/life goals such as purchase of residential house, marriage, education of children, medical expenses/ emergency, pandemics such as Covid-19 etc.
The government is in the process of implementing the new Labour Codes, likely to be effective from April 1, 2021. One of the important aspects of the code is to provide ‘social security for all’. In keeping with this spirit, there is a need to amend the tax laws also, to no longer subject EPF withdrawals to tax.
(The writer is Tax Partner at EY India. Ankur Agrawal, senior tax professional with EY, also contributed to this article. Views expressed are personal.)