Despite considerable alarm, the finance minister, for the time being, seems to be sticking to the plan of taxing a part of Employees Provident Fund (EPF) withdrawals. The government has issued a clarification explaining how this tax will work:
- Only 40 per cent of EPF withdrawals are tax-free, unlike 100 per cent earlier.
- 60 per cent of EPF withdrawal will be taxed as income if it is not invested in an annuity offered by an insurance company. However, the subsequent income stream from the annuity will be taxed.
- The new taxation will apply only to the corpus made with contributions to EPF account after 1st April. The current accumulated corpus, and its further accumulation, will not be taxed at all.
According to the official explanation, "The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account."
This is not applicable to those earning less than ₹15,000 a month, presumably because the government thinks that it's OK for low-earners to squander their PF after retirement. The government has decided that the only way to do so is to make people buy an annuity, or face the threat of confiscation of a good part of their savings in the form of tax. This is a strange attitude. This despite the fact that annuities available in India are a very poor deal. Annuity income is fully taxable, and the internal returns are around 6-7 per cent pre-tax.
Another big problem is that this tax will treat the accumulation of savings as income. When you encash your holdings from any long-term capital assets like mutual funds and real estate, then the principal amount is not taxed, and the gains are treated as capital gains. Long-term capital gains are either not taxed if held for a certain period (1 year for equity and equity funds) or taxed after adjusting for inflation (for everything else). However, the proposed tax will simply add it to the savers' income. 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.
If the real purpose of this 'reform' is really to prevent people from squandering their PF kitty, then it should be taxed as capital gains, and then some other more efficient kind of withdrawal option given to save the tax. To coerce everyone into one specific, low quality method of getting a regular income is the worst possible way to achieve the stated purpose. EPF savers are angry, and rightly so.