Indian social security contributions and tax easing – Community News
Social Security

Indian social security contributions and tax easing

the background

Until the 2019-20 fiscal year, only the employer’s contribution to an employee’s account that exceeded the prescribed thresholds was appropriately taxable in the hands of the employees. (See chart 1)

Contributions up to the prescribed threshold were not taxed at any time as these withdrawal funds followed the Free-Exempt-Exempt (EEE) regime.

Although a separate threshold was prescribed for each fund, there was no combined monetary threshold for the employer’s contribution to such funds. This allowed certain individuals to structure their pay in such a way that a large portion of their salary was paid by the employer in the designated funds. However, as the employer’s contribution was well within the above limits, the contribution was not taxable.

Moreover, given the EEA scheme, such contributions were never subject to tax. In the National Government Vide Financing Act 2020 it has been decided to provide a global ceiling for the employer’s contribution to PF, SAF and NPS.

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Retirement planning

New tax provisions

The Government Vide Finance Act, 2020 has decided to tax the employer’s contribution on these specified funds, above certain limits and the annual accrual thereon. This accrual may be in the form of interest, dividend or other amount of a similar nature.

Accordingly, with effect from FY2020-21, it was determined that if an employer’s total contribution to the specified funds exceeds 7.50 lakh (surplus contribution), the excess contribution will be taxable in the hands of the employee. . Such benefits will be included in the employee’s salary and taxed at the applicable plate rates. This also includes any interest or income accrued in respect of such overpayment.

Recently, the government has also disclosed the method of calculating the annual accretion via interest, dividend, etc. on such an overpayment. A formula-based approach is prescribed that requires, among other things, details about the opening and closing balances of these funds and the interest rates or NAVs, as the case may be.

Consequences for the employer

The employer is obliged to estimate and deduct the employee’s taxable wages during the financial year at the average tax rate. Accordingly, the employer is now required to withhold tax on the excess premium and annual accretion in these funds.

Challenges to come

As a result of the above changes and the prescribed calculation method, there are certain practical challenges that employers face and need to be addressed:

* Instances where the employer contributes to more than one specified fund. (See graph 2) In such cases, there is uncertainty as to how this co-payment, ie 50,000, must be calculated. In other words, the excess contribution would be due to which fund has not been clarified. Therefore, the question arises as to whether an employer can decide suo moto whether it can allocate equally to all funds in proportion to the contributions made by him.

It is pertinent to note that this would also affect taxable accretion, which is worked out differently for these specified funds.

* This method of calculating excess contribution accretion, applicable for 2020-21, was notified on March 5, 2021 and therefore companies must now take it into account when determining the taxes to be deducted for FY2020-21. This poses a practical challenge for the employer, namely the end of the financial year.

* Information such as the fund’s income and the opening and closing balances of the specified funds is not readily available from employers during the year. They must request this information from the employees and there may be data privacy concerns for the employees. Even if the employees are reluctant to share this information, the employer should also maintain adequate documentation to substantiate this information. This increases the administrative burden for employers.

* The other challenge would be in terms of availability of the interest rates, for example the interest rates for PF are not announced at the beginning of the fiscal year, it would be difficult to calculate the income accrued during the year. Accordingly, for such cases, the government should provide guidelines on how the taxable contribution should be calculated during the year. Does the employer have to account for last year’s interest or the average interest of the last two previous years, etc. One way to solve this problem is for the employer to make a value adjustment before issuance of Form 16, if the interest is at is available at that time or the employees could do so in his/her income tax return.

* In most cases, the accrued income for the entire financial year will only be determined after the end of the financial year, since the premium for March 2021 would also be part of the total amount on which the accrued income is determined. Clarity is therefore needed if the employer could make the correction in the coming financial year.

* There would be a distinct set of challenges when employees join or leave the organization during the year, ie cases where settlements are pending.

* In the case of specific NAV-based (NPS) funds, the NAV continues to change during the year and the final NAV is only available after the end of the fiscal year.

The above issues can lead to administrative challenges for both employers and employees. Different organizations may take different approaches, leading to unintended non-compliance, disputes and lawsuits. Some of these aspects therefore deserve attention and need to be clarified.

Vikas Vasal is a National Managing Partner Tax at Grant Thornton Bharat LLP.

Richa Sawhney and Ankita Chowdhry contributed to this article.

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