India’s social security contributions and extension of the tax system
India’s social security contributions and extension of the tax system

India’s social security contributions and extension of the tax system

The backdrop

Until the financial year 2019-20, only contributions from the employer to an employee’s account were more than the prescribed thresholds taxable in the hands of the employees. (See Figure 1)

Contributions up to the prescribed threshold were not taxed at any time when the Exempt-Exempt-Exempt (EEE) scheme was followed for these pension funds.

Although a separate threshold was set for each fund, there was no overall monetary limit for employer contributions to such funds. As a result, some individuals were able to structure their compensation in such a way that a large portion of their wages was paid by the employer in the funds provided. However, given that the employer’s contribution was well within the limits mentioned, the contribution was not taxable.

Furthermore, given the EEE scheme, such contributions were never taxable. The Government by the Finance Act 2020 decided to give an overall ceiling on the employer contribution to PF, SAF and NPS.

See the whole picture

Retirement planning

New tax provisions

The Government know the Finance Act, 2020 decided to tax the employer contribution to these specified funds, in addition to certain limits and annual growth thereafter. This increase may be in the form of interest, dividends or any other amount of a similar nature.

Consequently, with effect from FY2020-21, it was stipulated that if the total contribution of an employer to the specified funds exceeds `7.50 lakh (excess contribution), then the excess contribution will be taxable in the hands of the employee. . Such perquisitions will be included in the employee’s salary and taxed at the applicable record rates. This also includes the interest or income accrued in connection with such excess contribution.

Recently, the government also announced the way to calculate the annual growth rate in the form of interest, dividends, etc. on such an excess contribution. A formula-based approach is prescribed, which i.a. requires details of the opening and closing balance sheets of these funds and the interest rates or NAVs, as the case may be.

Consequences for the employer

The employer is obliged to calculate the taxable salary for employees and include withholding tax at the average tax rate in the financial year. Accordingly, the employer is now required to withhold tax on excess contributions and the annual accruals thereof in these funds.

Challenges ahead

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

* Cases where the employer contributes to more than one specified fund. (See Figure 2) In such cases, there is uncertainty as to how this excess contribution, ie 50,000 must be calculated. In other words, the excess contribution can be attributed to which fund has not been clarified. Therefore, a question arises as to whether an employer itself can determine or distribute it proportionately to all the means in the ratio of contributions which it has made.

It is pertinent to note that this will also have an impact on the taxable increments calculated differently for these specified funds.

* This method of calculating surplus contribution growth, applicable for 2020-21, was announced on 5 March 2021 and therefore companies should now consider this while determining the taxes to be deducted for FY2020-21. This poses a practical challenge for the employer, as the end of the financial year.

* Information such as the fund’s earnings and opening and closing balances for the stated funds are not readily available during the year with the employers. They need to seek these details from the employees and there may be concerns about data protection for the employees. Although employees reluctantly share this information, adequate documentation must also be maintained to substantiate this information by the employer. This will increase the administrative burden on employers.

* The second challenge would be in relation to the availability of interest rates, e.g. If the interest rates for PF are not announced at the beginning of the financial year, it would be difficult to calculate the accrued income during the year. Therefore, in such cases, the government should provide guidance on how the taxable profit should be calculated during the year. Should the employer consider the interest rate for the last year or the average interest rate for the last two previous years, etc. One way to solve this problem is for the employer to make a correction before issuing Form 16 if the rate is available before then or the employees could do so in their tax returns.

* In most cases, the earned income for the entire financial year will only be determined after the end of the financial year, as the contribution for March 2021 would also be included in the total amount on which the accrued income is to be calculated. So clarity is required if the collection can be carried out by the employer in the next financial year.

* There will be a separate set of challenges when employees join or leave the organization during the year, ie. cases where conciliation is pending.

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

The above issues can pose administrative challenges for both employers and employees. It is possible that different approaches may be adopted by different organizations, which may lead to unintentional non-compliance, dispute and litigation. Therefore, some of these aspects require attention and should be clarified.

Vikas Vasal is the national managing partner Tax at Grant Thornton Bharat LLP.

Richa Sawhney and Ankita Chowdhry contributed to this article.

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