Post-retirement EPF interest is taxed

Though the post-retirement interest income earned on EPF will be taxed, discuss with an advisor before withdrawing the amount

My friend Ajay had retired in early 2016. He had a substantial amount lying in his Employee Provident Fund (EPF) account which he decided to continue keeping there on the advise that he could continue to earn a tax-free interest of around 8.65 per cent for at least three years after retirement. 

In September, he read in newspapers that the interest payable on his EPF account, after employment, would be taxable as per a court decision. I had also read the same report and checked out the tribunal decision. Here are a few facts: The decision was in respect of an employee of a well-known software company who had resigned in 2002 itself, but had let his EPF money of Rs 38 lakh as it is in his EPF account.  He withdrew the money nine years later in 2011. 

By this time, the additional, interest income of Rs 44 lakh had bloated the total EPF kitty to 82 lakh. Note: It is not clear why he chose to withdraw the money in 2011 but it probably was in response to the Employee Provident Fund Organisation’s (EPFO) decision in 2011 to stop accruing interest on inoperative accounts three years after contributions stopped. The EPFO modified that decision to a certain extent in late 2016. 

In the above-mentioned case, the assessing officer claimed that the entire amount of Rs 82 lakh was taxable.  The original amount of Rs 38 lakh due on the resignation date was taxable because of reasons that are quite technical to enumerate here. The post-resignation interest income of Rs 44 lakh was taxable because interest on EPF post-cessation of employment was not tax-free. 

While the tribunal overruled the technical reasons given for not allowing exemption of the pre-resignation amount of Rs 38 lakh, it agreed with the view of the assessing officer that the interest after resignation date is taxable. 

The decision has caught the EPFO offguard also. For example, even if you lose your job, the EPFO requires a minimum cooling off period of two months before you can withdraw your PF amount. EPFO is clearly unaware that the interest payable for this cooling period may be taxable. 

If Ajay accepted that the interest on EPF would be taxable, it would not necessarily follow that he should withdraw the amount. For all purposes, he should treat this like a bank fixed deposit on which he is accruing interest at 8.60 a year. In Ajay’s case, his taxable income even without this EPF interest was in excess of Rs 10 lakh which means his tax rate was 30 per cent. 

Effectively, the 8.60 per cent a year interest on EPF is equal to around 6 per cent after tax. He might get better return than that in a debt fund if he held it for more than 36 months. So, in his case, it made sense to withdraw the EPF money and invest in a debt mutual fund. This may not necessarily be true for other people under different assumptions on tax rates. But in all cases, it would necessitate a chat with your tax advisor to account appropriately for the EPF interest in the income tax returns. 

The author is a Sebi-registered fee-only investment advisor