Taxability of Interest Accrued on Employee Contribution to Recognized fund

 

Taxability of Interest Accrued on Employee Contribution to Recognized fund

 

·         Issue

1.      Section 10(12) provides that accumulated balance becoming due and payable to employee from Recognized Provident fund (RPF), which is not taxable as per rule 8 of part A of Schedule IV of Income Tax Act, shall be exempt

2.       Finance Act 21, appended a proviso to this section to the effect that said provision will not be applicable in respect of Interest accrued in previous year on annual employee contribution in excess of Rs. 2.50/5.00 lacs (Prescribed Amount) . The Interest is to be computed in a manner prescribed by rule 9D of Income Tax Rules.

3.      The issue under considerations are twofold:-

a)      Whether Annual Interest (Taxable Interest) accrued in previous year on employee contribution in excess of prescribed amount is taxable in PREVIOUS YEAR itself or will it be taxable at time accumulated PF balance becomes due or payable to an employee?

b)      Whether any TDS is to be deducted on such taxable interest and if yes, then when and at what rate?

 

Explanation

A.     Existing (Pre-Amended) Taxability in connection with RPF

Legal Frame work of Recognized Provident Fund

a)      It needs to be organized as Trust and registered under Income Tax Act, as per Part A of Fourth Schedule to Income Tax Act, 1961

b)      The Income received by trustee of Recognized Provident Fund is exempt  u/s 10(25)

 

1.      Employer’s Contribution to Employee Provident Fund

a)      Employer’s Contribution in excess of 12% of Salary – It will be taxable under head Salary in the year in which such excess contribution is made by Employer ( Section 17(1)(vi) of  Income Tax Act)

b)      Employer Contribution upto 12% of Salary- If aggregate contribution to RPF, NPS, Superannuation fund exceeds Rs. 7.50 lacs per year, the excess will be taxable as per perquisite under the head Salary ( Section 17(1)(vi))

 

2.      Interest on Balance (Employee and Employer Contribution) in RPF

a)      Interest rate is upto prescribed Rate – Nothing is taxable in the hands of employee on annual basis, the reason is as under;-

i)                    RPF is organized as Trust

ii)                  The income of trust is taxable either in the hands of trustee or in the hands of beneficiaries.

iii)                The income of Trustee of RPF is made exempt u/s 10(25). Since income of RPF is made exempt, the annual interest credited to employee account is also not taxable.

 

b)      Interest rate is exceeding the prescribed rate – The excess interest so calculated is taxable under the head salary in the year in which such interest is credited to employee account. ( Section 17(1)(vi) of  Income Tax Act)

 

3.      Accumulated Balance in RPF due and payable ( Balance payable to employee, when he ceased to be employee of employee)

a)      Complying with conditions stated in Rule 8 of Part A of fourth Schedule ( Continuous employment for 5 years etc.) –  Such balance is not taxable as per section 10(12) of Income Tax Act

b)      Not Complying with Condition Stated in said Rule – The accumulated balance become taxable and the taxability of such balance is worked as if the provident fund was unrecognized.

 

4.      TDS on taxable income relating to RPF

a)      Contribution by employer in excess of 12% or Interest in excess of Prescribed rate - Such amount is taxable under the head Salary on annual basis and TDS is deducted thereon u/s 192.

b)      Accumulated balance taxable (not complying with Rule 8) – TDS on such accumulated balance is deducted @ 10% u/s 192A

 

Thus under pre-amended scenario, if interest rate is within prescribed rate, there is no taxability of Interest on annual basis, though such amount may be made taxable at the time when accumulated balance is received, if Rule 8 conditions are not complied with.

 

B.     Amendment by Finance Act 2021

1.      In the entire gamut of taxability in connection with RPF, Finance Act 2021 has just made amendment in section 10(12) and same is reproduced as under:-

“Section 10 - In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included---

(12) The accumulated balance due and becoming payable to an employee participating in a recognized provident fund, to the extent provided in rule 8 of Part A of the Fourth Schedule;

Following provisos shall be inserted in clause (12) of section 10 by the Finance Act, 2021, w.e.f. 1-4-2022 :

Provided also that the provisions of this clause shall not apply to the income by way of interest accrued during the previous year in the account of a person to the extent it relates to the amount or the aggregate of amounts of contribution made by that person exceeding two lakh and fifty thousand rupees in any previous year in that fund, on or after the 1st day of April, 2021 and computed in such manner as may be prescribed :

Provided further that if the contribution by such person is in a fund in which there is no contribution by the employer of such person, the provisions of the first proviso shall have the effect as if for the words "two lakh and fifty thousand rupees", the words "five lakh rupees" had been substituted”

2.      As per literal interpretation, the above amendment explicitly state that annual interest computed on employee contribution in excess of Rs. 2.50 lacs/5.00 lacs, will not be exempt, when such interest is received at the time accumulated balance of RPF is payable to employee. Further Memorandum to Finance Bill 2021 also does not state that such taxable interest will be taxable on yearly basis.

3.      Neither there is amendment in section 15 or 17 or section 56 mandating that annual Interest so computed as per Rule 9D of Income Tax rules will be taxable on annual basis.

4.      Further neither section 192 nor 194A has been amended so as provide for yearly deduction of TDS on such taxable interest. Thus there is no need for TDS deduction on such taxable interest on annual basis. Till any further amendment, deduction on such taxable interest will be governed by Section 192A, at the time, when accumulated balance is paid to employee.

Thus in my view, the annual interest computed on employee contribution in excess of Rs. 2.50/5.00 lacs is taxable only at the time of Accumulated balance is paid to employee ( not on annual basis) and there is no need to deduct annual TDS on such Interest Amount.

Taxability on Reconstitution of Partnership Firm- Amendment by Finance Act 2021

 

Finance Act 2021 has heralded new legislation to restraint the use of Partnership FORM of Organization, for tax planning. To this end, legislation has incorporated  new section (9B) and re-casted existing section (45(4)) under Income Tax Statue. These provisions are applicable from Assessment year beginning from 1^st April, 2021

In the ensuing write-up, I have tried to explained the said provisions, along with illustration and expounded many unsettled question expected to arise on implementation of new provisions

Taxability on Reconstitution of Partnership Firm- Amendment by Finance Act 2021.

 

Section 9B

1.      Following event (Specified event) took place in the Partnership firm/AOP/BOI (FIRM)

a)      Dissolution

b)      Change in Profit Sharing ratio

c)      Retirement of Partner

d)      New Person is admitted as  a partner in FIRM

 

2.      Partner/Member (specified person) of Firm, AOP or BOI received Capital asset or stock in trade from FIRM in connection with specified Event.

3.      In above conditions are satisfied, then FIRM is deemed to have TRANSFERED such capital Asset or stock in trade to specified Person

4.      There arise Profit or gains on such transfer to be computed on the basis of  Sales consideration (Stock in trade or Capital Asset) to be taken at FMV of the asset on the date of transfer.

5.      Such Profit or gains shall be chargeable to tax in the hands of FIRM under the hands PGBP or Capital gains, in accordance with the provision of Act,

6.      If any difficulty arises in giving effect to provision of section 9B, CBDT is empowered to issue guidelines for removing the difficulty.

 

Section 45(4)

1.      Section override Section 45(1)

2.      There is either change in profit Sharing ratio, retirement or admission (Reconstitution) of Partner in FIRM (Dissolution not Covered)

3.      Partner receives Capital asset or Money from FIRM in connection with re-constitution.

4.      On receipt of capital Asset or money, Profit & gains arises to such partner.

 5.      Such Profit & gain

a)      Shall be chargeable to Income Tax under the head “ Capital gains”  and

b)      Shall be deemed to be income of the FIRM in the previous year in which money or capital asset is received by partner

 6.      Profit & Gains will be computed as under:

a)      Money received + FMV of Capital Asset Received less Balance in capital Account of such partner at the time of reconstitution (without taking into account the increase in the capital account of the specified person due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset.)

b)     If above working results in negative amount, then gain shall be considered as ZERO

 

Amendment in section 48

1.      In calculating capital gain u/s 45(1) pursuant to section 9B, the Capital gain will be computed as under;-

a)      FMV of Capital Asset transferred to Partner

b)      Less: Cost/Indexed cost of Acquisition/Improvement

c)      Less: Capital gain chargeable to tax u/s 45(4) on transfer of Capital Asset to Partner

 

 

Taxability – Summary

Group	Transaction	Section 45(4)	Section 9B
Reconstitution of firm (Change in PSR, Admission or Retirement of Partner)	Receipt of Money by Partner	Taxability will be computed	No Taxability
	Receipt of Capital Asset (from firm’s perspective) by Partner	Taxability will be first computed	Then, taxability will be computed in pursuance of section 9B under section 45(1) & 48
	Receipt of Stock in Trade	No Taxability	Taxability will be computed in pursuance of section 9B , as per provisions applicable for PGBP
Dissolution of FIRM	Receipt of Money	NOT Applicable	Not taxable
	Receipt of Capital Asset		Taxability will be computed in pursuance of section 9B under section 45(1).
	Receipt of Stock in Trade		Taxability will be computed in pursuance of section 9B , as per provisions applicable for PGBP

 

 

The above provision can be illustrated with Example

A.     Transfer of Capital Asset on retirement of Partner

 

1.      There are 3 partners (A,B & C) each having Capital of Rs. 3 lacs on 31-03-2021

2.      There are 3 capital assets X- Rs. 4 lacs, Y – Rs. 4 lacs and Z – Rs. 1 lacs. All Assets acquired on 01-04-2017

3.      A retires and he was given Asset Z, having FMV of Rs. 10 lacs

Tax Implications

i)                    Taxability U/s 45(4) – {FMV of Asset- Capital Balance) – Rs. 7 lacs ( 10-3).

ii)                  Taxability pursuant to section 9B and will be taxable u/s 45(1)

FMV of Capital Asset                                Rs. 10,00,000

Less: Indexed Cost of Acquisition              Rs.   1,10,661 (1,00,000 x 301/272)

Less: Capital u/s 45(4)                              Rs.   7,00,000

Long Term Capital Gain                          Rs. 1,89,339

 

B.      Transfer of Stock in trade on retirement of Partner

1.      There are 3 partners (A,B & C) each having Capital of Rs. 3 lacs  as on 31-03-2021.

2.      A retires and he was given stock in trade (Book value – Rs. 2 lacs), having FMV of Rs. 10 lacs

Tax Implications

i)                    Taxability pursuant to section 9B and will be taxable u/s 28

FMV of Stock in Trade                              Rs. 10,00,000

Less: Book value                                        Rs.   2,00,000

PGBP                                                         Rs. 8,00,000

 Unresolved Issues

1.      Nature of Capital gain (Long term and Short term) u/s 45(4)

a)      Section 45(4) is departure from Normal Capital Gain taxation rules. Capital gain arises on transfer of Capital Asset

b)      U/s 45(4), receipt of money or Capital Asset (FMV) by partner in excess of balance in his capital Account, is chargeable to tax under the capital gains and such capital gains though accrue to partner, but same is taxable in the hands of FIRM. Law does not deem any transfer of Capital Asset u/s 45(4) and gain arising in pursuant thereto.

c)      In the absence of transfer of Capital Asset, there cannot be Short term or long term capital gain, as same is dependent upon the holding period of capital asset before its transfer.

d)     Thus Section envisage special capital gain and following implication draw from thereupon

i)                    Setting of bough forward loss - If Partner has bought forward Long term Loss under the head Capital gain, whether it can be set-off against the special capital gains. Long term capital loss can be set-off against Long term capital gain only. In the absence of nature of special capital gain, this point needs clarification.

ii)                  Place of Accrual of Capital Gains- Capital gain on transfer of Capital Asset situated in India is deemed as accrue or arise in India u/s 9. In  case of special capital gain, there is no transfer of Capital gain. In the absence of specific provision, as regard place of accrual of special capital gain, the taxability of same in the hands of Non-resident is questionable

 2.      Implication of Double taxation in the hands of FIRM

a)      Under Section 45(4), money paid to retiring partner in excess of balance in his account is deemed as Capital gain. The excess amount, generally, represents unrealized appreciation in the value of Firm’s asset as on the date of retirement.

b)     Though unrealized gain is made taxable in the hands of FIRM, but there is no corresponding provision for increase in the value of asset in the hands of FIRM

c)      Explained as under:-

i)                    Suppose there are 3 partners (A,B,C), each having capital balance of Rs. 2 lacs and C retires.

ii)                  One capital Asset (X) (book value – Rs. 3 lacs) is having market value of Rs. 12 lacs. C will be credited with his share of appreciation – Rs. 3 lacs ( 9 lacs x 1/3)

iii)                C capital account stands at Rs. 5 lacs ( 2+3) and Rs. 3 lacs is profit accruing to C and will be made taxable in the hands of FIRM as capital gain.

iv)                Suppose immediately after C’s retirement, FIRM sold capital asset (X) at Rs. 12 lacs and made capital gain (STCG) of Rs 9 lacs ( 12-3). But out of Rs. 9 lacs, Rs. 3 lacs has already been taxable in the hands of FIRM on C’s retirement and same is again made taxable on actual capital gain.

v)                  There needs to be provision for enhancement in the COST OF ACQUISITION  of capital assets, whose unrealized gain is being made taxable in the hands of retiring partner earlier.

 3.      Implication of Double Taxation in the hands of retiring partner

a)      Under Section 9B, on receipt of capital asset by retiring partner, taxability is casted on the FIRM on the basis of FMV of Capital Asset. But there is no corresponding provision for cost of Acquisition (COA) to be taken as FMV, in the hands of retiring partner

b)      Explained as under

a)      Suppose C, having Capital balance of Rs. 2 lacs, was given Capital Asset (book value- Rs. 3 lacs) having FMV at Rs. 9 lacs

b)      The FIRM will be made taxable on aggregate of capital gain (9B+45(4)) of Rs. 7 lacs ( 1+6).

c)      The partner has been given Capital Asset at Rs. 3 lacs, but firm is being made taxable on the basis of FMV of capital Asset i.e Rs. 9 lacs

d)      As per existing provision of section 48, COA in the hands of partner will be taken at Rs. 5 lacs, which should have been Rs. 9 lacs.

e)      Thus in the absence of explicit provision u/s 55 for FMV being COA in the hands of retiring partner, there will be double taxation, when he will sell such asset in future.

4.      Complexity in Computation Mechanism.

a)      Under new taxability provision, Capital gain on transfer of Capita Asset to retiring partner  is first computed u/s 45(4) and then same is allowed as deduction, while computing Capital gain envisage in section 9B

b)      If retiring Partner is given both money and Capital asset on retirement, then there is no provision to determine the capital gain accruing on transfer of Capital Asset.

c)      Explained as under

i)                    Suppose Partner C (having Capital Balance – Rs. 2 lacs) retires. He is given money of Rs. 3 lacs and Capital Asset (book value- Rs. 4 lacs) – Rs. 10 lacs (FMV)

ii)                  The Taxable Capital under section 45(4) and 9B will be work out as under:-

Particulars	Section 45(4)	Section 9B
Money Paid to Partner	3,00,000
FMV of Capital Assets	10,00,000
Less: Balance in Capital Account	2,00,000
Capital Gain u/s 45(4)	11,00,000
FMV of Capital Asset		10,00,000
Less; Book Value of Capital Asset		4,00,000
Less: Capital Gain on transfer of Capital Asset made taxable u/s 45(4). It Cannot be worked out, since capital gains  u/s 45(4) has been worked out on the basis of aggregate Consideration comprising payment of money and FMV of Asset. There is no provision to work out capital gain u/s 45(4) proportionate to receipt of capital asset by Partner		????????

 

5.      Deemed transfer u/s 9B- Weakness in Strengthening taxability

a)      Section 9B provides that if there is dissolution of firm or reconstitution in the firm, receipt of capital asset or stock in trade is DEEMED as transfer and gain arising in pursuant thereto will be taxable under the head Capital gains or PGBP. Same hold u/s 45(4).

b)     It implies that if partner receives capital asset or stock in trade during tenue of partnership or without there being reconstitution in FIRM, then such transaction will not be considered as transfer, as u/s 9B deeming transfer arising on dissolution or reconstitution of FIRM only.

c)      This aspect could render entire taxability u/s 9B & 45(4) ineffectual, explained as under

i)                    Suppose there are 3 partner, each having Capital balance of Rs. 2 lacs. Asset (Book value- Rs. 6 lacs) of the firm has market value of Rs. 27 lacs.

ii)                  Firm carried out revaluation of Assets and credited the revaluation gain of Rs. 21 lacs, in equal proportion (7 lacs each). Now capital balance of each partner stands at Rs. 9 lacs ( 2+7).

iii)                Suppose C receive an asset of Rs 9 lacs (FMV) again his capital balance. There will not be any taxability either u/s 9B or Section 45(4), as C has not retired

iv)                Suppose after 1 year of this transaction, C retires. Now on this retirement there is no taxability, as no capital asset is being transfer on retirement, which has already been done earlier during C tenure as Partner

d)      This loophole needs to be curbed in order to strengthen the revised taxability u/s 9B and 45(4).

 6.      Whether deemed Transfer u/s 9B is specific or General

a)      Section 9B provides receipt of Capital Asset or stock in trade by Partner on reconstitution or dissolution of firm as Transfer

b)      The Point of consideration is whether such transaction is transfer for computing taxable income as envisage in section 9B ONLY or it is transfer for all other intent under Act, enunciated  as under

i)                    If there is transfer of Immovable property in excess of Rs. 50 lacs to partner on retirement, whether partner will be required to deduct TDS u/s 194IB?

ii)                  If the FMV of Capital Asset transfer on retirement is less than FMV envisage u/s 56(2)(x), whether partner will also be taxable u/s 56(2)(x) for excess of FMV u/s 56(2)(x) and section 9B.

 

7.      FMV of Stock in Trade u/s 9B- Whether treated as Turnover ??

a)      Under Section 9B, receipt of stock in trade on retirement of partner is treated as Transfer of stock in trade and firm is being taxable on the basis of FMV of stock in trade.

b)      Question for consideration is, whether such transfer of stock in trade at FMV, is treated as TURNOVER, as many provision under the Act is contingent upon level of turnover, explained as under:-

i)                    Tax Audit is dependent upon Turnover

ii)                  TDS u/s 194Q is dependent upon Turnover

iii)                TCS u/s 206C is also partly dependent upon Turnover

 

I hope that government will suitably consider the above points and will issue guidelines in the due course to resolve the unsettled aspects in implementation of Section 9B and section 45(4)