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India social security contributions and widening of the tax regime

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The backdrop

Till financial year 2019-20, only contribution by the employer to the account of an employee more than the prescribed thresholds was taxable as perquisite in the hands of the employees. (See Chart 1)

Contributions up to the prescribed threshold did not get taxed at any point of time, since Exempt-Exempt-Exempt (EEE) regime was followed for these retiral funds.

Even though a separate threshold was prescribed for each fund, there was no combined monetary threshold for employer’s contribution to such funds. As a result of this, certain individuals were able to structure their compensation in a manner that a large portion of their salary was paid by employer in the specified funds. However, given that the employer’s contribution was well within the aforesaid limits, the contribution was not taxable.

Further, given the EEE regime, such contributions were never subject to tax. The government vide Finance Act 2020 decided to provide an overall cap on the employer’s contribution to PF, SAF and NPS.

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Retirement planning

New taxation provisions

The government vide Finance Act, 2020 decided to tax the employer contribution to these specified funds, in excess of certain limits and annual accretion thereon. This accretion could be in form of interest, dividend or any other amount of similar nature.

Accordingly, effective FY2020-21, it was provided that if the aggregate contribution made by an employer to the specified funds is in excess of `7.50 lakh (excess contribution), then the excess contribution will be taxable as perquisite in the hands of the employee. Such perquisites will be included in employee’s salary and taxed at the applicable slab rates. This also includes the interest or income accrued in respect of such excess contribution.

Recently, the government also notified the manner of computing the annual accretion by way of interest, dividend, etc., on such excess contribution. A formula-based approach has been prescribed which, inter-alia, requires details of opening and closing balance of these funds and the interest rates or NAVs, as the case may be.

Implications for the employer

The employer is required to estimate the taxable salary of employee and withhold tax at average rate of tax during the financial year. Accordingly, the employer is now required to withhold tax on excess contribution and the annual accretions thereon in these funds.

Challenges ahead

As a result of the aforesaid changes and computation methodology prescribed, there are certain practical challenges being faced by employers which need to be addressed:

* Cases where employer is contributing to more than one specified fund. (See Chart 2) In such cases, there is lack of clarity on how this excess contribution i.e. 50,000, is to be computed. In other words, the excess contribution would be attributable to which fund has not been clarified. Therefore, a question arises whether an employer can suo moto decide or allocate it proportionately to all the funds in the ratio of contribution made by it.

It is pertinent to note that this would also have a consequential impact on the taxable accretions as well, which are worked out differently for these specified funds.

* This methodology for computation of accretion on excess contribution, applicable for 2020-21, was notified on 5 March 2021 and hence, companies need to now consider this while determining the taxes to be deducted for FY2020-21. This poses a practical challenge for the employer, being the end of the financial year.

* Information like the earnings of the fund, and opening and closing balance of the specified funds is not readily available during the year, with the employers. They need to seek these details from the employees and there may be data privacy concerns for the employees. Even if the employees reluctantly share these details, adequate documentation to substantiate this information would also need to be maintained by the employer. This will add to the administrative burden for the employers.

* The other challenge would be in terms of availability of the interest rates e.g. the interest rates for PF are not announced at the beginning of the financial year, it would be difficult to compute the income accrued during the year. Accordingly, for such cases, the government should provide guidance regarding the manner in which the taxable perquisite is to be computed during the year. Should the employer consider the interest rate of last year or average interest rates of last two previous years, etc. One way to resolve this issue is that a true-up is done by employer before issuing Form 16, if the rate is available by then or the employees could do so in his / her income tax returns.

* In most cases, the income accrued for the entire financial year will be ascertained only after the end of the financial year, since the contribution for March 2021 would also form part of the total amount on which the accrued income is to be determined. So, clarity is required if the true-up could be done by employer in the next financial year.

* There would be a separate set of challenges when employees join or leave the organization during the year i.e. cases where settlements are pending.

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

The above issues may lead to administrative challenges both for the 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 national managing partner–Tax at Grant Thornton Bharat LLP.

Richa Sawhney and Ankita Chowdhry contributed to this article.

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