Direct Tax Alert - CBDT prescribes rules for determining taxable accretion on certain social security funds

Background

With an intent to curb undue tax benefit taken by taxpayers earning high salary income, the Finance Act, 2020 provided¹ a combined cap of INR 0.75mn in respect of employers’ contribution made to following social security funds:

• Recognised Provident Fund
• Approved Superannuation Fund
• National Pension Scheme

It also provided² that any annual accretion (interest, dividend, etc.) to these social security funds during the fiscal year (FY) on employer’s contribution exceeding the combined upper limit of INR 0.75 Mn shall be taxed as perquisite in the hands of employee under the Income-tax Act, 1961 (‘IT Act’). The mechanism for computing the taxable annual accretion was to be prescribed.

Recently, the Central Board of Direct Taxes (CBDT) issued a notification³ inserting new Rule 3B to the Income-tax Rules, 1962 (‘IT Rules’) to provide the mechanism of computing taxable annual accretion.

We, at BDO in India, have analysed and summarised the said notification and provided our comments on its impact hereunder:

Formula for computing annual accretion referred to in section 17(2)(viia) of the IT Act

New Rule 3B of the IT Rules prescribes following formula for computing the value of annual accretion on excess employer contributions:

Note- Where the amount or aggregate of amounts of TP1 and PC1 exceeds the amount or aggregate of amounts of balance to the credit of the specified funds on the first day of the current FY, then such excess shall be ignored for the purpose of computing the amount or aggregate of amounts of TP1 and PC1.  

BDO comments

The formula prescribed by the CBDT can be understood with the following illustration:

(INR in Mn)       

Taxable amount as per the formula: TP= (PC/2)*R + (PC1+TP1)*R

(INR in Mn)       

It is pertinent to note that while Section 17(2)(via) of IT Act was introduced w.e.f. 1 April 2020 (FY 2020-21) to tax the excess employer contributions and accretions thereon, the new Rule 3B for computing taxable accretions is introduced w.e.f. 1 April 2021 (i.e. FY 2021-22). Both being taxable as perquisite, fall under the head ‘Salaries’ and thereby the withholding tax obligation would need to be carried out by the employer. This could pose below practical challenges for employers:

• If the tax officer takes a view that the Rule is applicable retrospectively from FY 2020-21, then the timing of tax withholding on such accretions for FY 2020-21 could be a challenge.
• The employer is only privy to the information relating to the concerned employer’s contribution to the fund. As such, the information relating to opening/closing balance, annual accretion, contributions other than the concerned employer, withdrawal from the fund, etc. may not be readily available with the employer. The employer would need to request these from the employee in order to undertake appropriate tax withholding.
• Tracking would be required on the taxable perquisite for each employee over the past FYs.
• Accurate computation of the taxable perquisite value considering the complex formula.
• The employer could be exposed for short deduction of tax and consequential interest and penal implications may apply.