Taxation of employers’ contributions in employee’s return of income

Up-to assessment year 2020-21:

There was no upper cap on the employer’s contribution to the various employee welfare schemes. Separate provisions were available in the Income-tax Act to tax such contribution, i.e.,

  1. Superannuation fund was taxable as perquisite under Section 17(2)(vii)in the hands of the employee only if such contribution exceeded Rs. 1,50,000 during the year.
  2. The employer’s contribution to the NPS is taxable in the hands of the employee and included in his salary income. However, a corresponding deduction is allowed to the employee for such contribution to the extent of the lower of the amount contributed by the employer to NPS, or 14% of salary in case of Central Government employee or 10% of salary in case of any other employee.
  3. Employer’s contribution, exceeding 12% of salary, in EPF account is charged to tax in the hands of employees.

Finance Act 2020 :

The substituted Section 17(2)(vii) introduce an overall cap on the maximum contribution an employer can make towards Recognized Provident Fund (PF), National Pension Scheme (NPS), and Superannuation Fund (hereinafter referred to as ’employee’s welfare Funds’).

This clause provides that the aggregate contribution to employee’s welfare funds in excess of Rs. 750,000 shall be taxable as perquisite in the hands of the employees. However, the existing provisions relating to the contribution to NPS and PF remain the same.

Reason for amendment – to curb the benefits of high-income employees :

All the employee’s welfare funds enjoy the EEE status (Exempt-Exempt-Exempt) whereby no tax is levied at the time of contribution, accretion, and withdrawal if the same is within a certain limit. Thus, the employees with high salary income were obtaining the undue advantage of this taxation regime by designing their salary package in a manner in which a substantial part of the salary is paid by the employer by way of contribution to these funds and, consequently, that portion of salary does not suffer tax at any point.

Manner of computation :

A new sub-clause (viia) has also been inserted to Section 17(2) that the annual accretion by way of interest, dividend or any other amount of similar nature during the previous year, relating to contribution in excess of Rs. 750,000, shall also be taxed as a perquisite in the hands of the employee. Hence, the CBDT has inserted a new Rule 3B to prescribe the manner for computation of such annual accretion by giving the following formula in this regard:

Taxable perquisite under section 17(2)(viia) for the current previous year **, i.e., TP = (PC/2)R + (PC1+ TP1)R

Where,

a) TP = Taxable perquisite under section 17(2)(viia) for the current previous year;
b) TP1 = Aggregate of taxable perquisite under section 17(2)(viia) for the previous year(s) commencing on or after 01-04-2020 other than the current previous year.
c) PC = Aggregate of the principal contribution made by the employer in excess of Rs. 7.50 lakh to the employee’s welfare funds during the previous year;
d) PC1 = Aggregate of the principal contribution made by the employer in excess of Rs. 7.50 lakh to the employee’s welfare funds for the previous year(s) commencing on or after 01-04-2020 other than the current previous year;
e) R = I/ Favg;
f) I = Aggregate of income accrued during the current previous year in the employee’s welfare funds;
g) Favg = (Aggregate of balance to the credit of the employee’s welfare funds on the first day of the current previous Year + Aggregate of balance to the credit of the employee’s welfare funds on the last day of the current previous year)/2

Where, PC1+ TP1 > aggregate of balance to the credit of the specified fund or scheme on the first day of the current previous year = the amount in excess of the aggregate of amounts of the said balance shall be ignored to compute the aggregate of amounts of TP1 and PC1.

To put in simple terms,

The perquisites arising from the annual accretion on the employer’s contribution to welfare funds shall be the average return (I/Favg) on the sum of:

a) ½ of the current year’s contribution in excess of Rs. 750,000;|
b) Contribution in excess of Rs. 750,000 up to last year; and|
c) Accretion taxable as perquisite up to last year.|

If the sum of (b) and (c) exceeds the opening balance of the fund, it shall be restricted to such opening balance.

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Thanks @Ankit very helpful.

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