India’s Union Budget 2016- a Personal Tax perspective

In the backdrop of an uncertain global economy and the need for political recalibration, the Finance Minister has presented a politically prudent budget within the contours of fiscal discipline. The Finance Minister, while presenting the Budget, expressed his desire to provide socio-economic security to every Indian especially the farmers, the poor and vulnerable. This is evident from the initiatives announced for the social, agriculture, health care, education, skill development and infrastructure sectors.


The Budget directionally has a transformative agenda. Although, it may have disappointed some but we should stop expecting big ticket bonanzas every time a budget is announced.

Some benefits that will clearly bring relief to small taxpayers are the increase in tax rebate for taxpayers with income less than INR 500,000 to INR 5,000 (from INR 2,000), raised tax deduction limit for rent paid for housing (for individuals who do not receive house rent allowance from their employers) from INR 24,000 to INR 60,000 per annum and an additional deduction of INR 50,000 for mortgage interest for first-time home buyers (subject to certain conditions).

The socialist flavor of the budget is, however, echoed in the increase in the effective tax rate from 34.608% to 35.535% for individuals with income above INR10 million by way of a surcharge of 15% on tax and levy of a 10% tax on dividends from domestic companies in excess of INR 1 million, which was hitherto not taxed. The other mentionable proposal is the Income Tax Declaration Scheme 2016, which I am hoping will, with its “no questions asked” framework, flush out untaxed income and help garner additional revenue. The adoption of tax simplification measures, as suggested by Justice Easwar Committee, use of technology to promote transparency and expedite the process and the move to paperless audits, the intention to reduce backlog of pending tax issues through a new dispute resolution scheme are all positive steps in the direction of a transformational philosophy.

However, the proposed changes to bring parity in taxation of pension plans — Superannuation Fund, National Pension System (NPS) and Recognised Provident Fund (RPF) had attracted the most attention.).

Under existing tax law, the taxability of these above-mentioned pension plans work as follows:

  1. An RPF operates on an exempt-exempt-exempt (EEE) principle of taxation, which means that contributions to the Fund, interest on the accumulations and withdrawal from the Fund — all three stages are fully exempt from taxation
  2. Superannuation Fund operates on partially exempt-exempt-taxable (EET) principle of taxation which means that employer’s contribution to super annuation is exempt from tax up to INR 100,000 ( proposed to be increased to INR 150,000), interest on the cumulative fund is exempt from tax and on withdrawal of one-third of the amount is permitted to be withdrawn as a lump sum on retirement while two-third of the accumulation is commuted into an annuity plan such that the monthly pension received from the annuity plan is fully taxable.
  3. National Pension System operates on EET basis, since both partial lump sum on retirement and regular pension from the annuity plan is fully taxable.

Budget 2016 proposals in relation to taxability pension plans were as follows:

  1. Employer’s contribution to RPF will be taxable if above INR 150,000 or 12% of salary, whichever is lower (under the existing law — employer’s contribution is taxable only if it exceeds 12% of salary)
  2. Withdrawal from RPF — change in scheme of taxation — tax exemption restricted to 40% of the accumulated balance attributable to employee’s contributions made after 1 April 2016 (under the existing law — withdrawal from RPF is exempt from tax if period of continuous service is more than five years)
  3. Employer’s contributions to Superannuation Fund is proposed to be exempt from tax for up to INR 150,000 (under the existing law — tax exempt amount is INR 100,000)
  4. Withdrawal from Superannuation Fund: It is proposed that payment in lieu of or in commutation of annuity out of contributions made after 1 April 2016 will be taxable in excess of 40% annuity (under the existing law — any amount received on account of death or on commutation of annuity on retirement or after the specified age was not taxable).
  5. Withdrawal from National Pension System: It is proposed that up to 40% of accumulations on closure of account or opting out of NPS will not be taxable (under the existing law — withdrawal from NPS is fully taxable).
  6. One time portability of funds from RPF and SAF to NPS will be non-taxable.

The Budget had sought to provide uniform tax treatment for all the three schemes by exempting from tax 40% of the amount available on withdrawal. NPS has failed to become popular because of taxability at the time of withdrawal. The proposed change is a welcome move and clearly intended to encourage and push funds into NPS.

The proposed changes around taxability of RPF had triggered wide spread criticism and given the public controversy on this topic, a roll back of these changes has been announced on 8 March 2016.

But all said and done the changes proposed were well intentioned as beyond taxation, the objective is to ensure pension security on and after retirement for members of RPF. In fact the recent change in the Employee Provident Fund Rules, wherein an employee can claim only partial withdrawal (consisting of employee’s contribution and interest thereon) and will have to wait until the age of 58 years to withdraw the remaining corpus attributable to employer’s contribution is also inspired by the need to ensure pension security for the old.

The Government does have a tough task of managing expectations of employees used to an exempt-exempt-exempt tax regime. It will always be a tough transition to exempt-exempt tax. Moreover, the pension reforms agenda has been on the table for some time and needs a push as India scores very poorly on the available retirement benefits from a global perspective.

My suggestions for managing this transition and the purpose of socio-economic security and planning for a young population that will eventually get old (alas!) are as follows:

  1. There is a need to create awareness about the need to save for retirement and build a public opinion favoring mandatory retirement savings plans.
  2. The Government should try to bring about parity in the operation of schemes along with tax neutrality — currently RPF and SAF as opposed to NPS all allow different withdrawals and under different circumstances.
  3. There should be a plan for the transition in a time horizon of two to three years.
  4. The Government should allow employees to choose between retirement plans depending on the risk-taking profile of the individual.
  5. The current perception of being forcefully made to migrate to NPS has created resentment.
  6. Draft for public discussion should be circulated on directional changes in the long run and proposed changes in the short run.

A balanced view on this extremely sensitive issue is the need of the hour and the FM will have his hands full in trying to get the balance of acceptability in the short run and what must be done from a long run pension vision.

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