Tax treatment of the accumulated balance of recognised provident funds (RPFs) : Clause 191 of the Income Tax Bill, 2025 Vs. Section 111 of the Income-tax Act, 1961

Clause 191 Tax on accumulated balance of recognised provident fund.

Income Tax Bill, 2025

Introduction

The taxation of provident fund accumulations has long been a significant issue within the Indian income tax framework, reflecting the dual policy objectives of incentivizing long-term savings for employees while ensuring that tax benefits are not misused. Clause 191 of the Income Tax Bill, 2025 (hereinafter "Clause 191") proposes to regulate the tax treatment of the accumulated balance in recognised provident funds (RPFs) when certain prescribed conditions for exemption are not met. This commentary undertakes a detailed statutory analysis of Clause 191, juxtaposing its provisions with the existing Section 111 of the Income-tax Act, 1961 and the relevant rules in Part A of the Fourth Schedule (hereinafter "Schedule 04") to the 1961 Act. The analysis explores legislative intent, operational mechanics, interpretational nuances, and practical implications for stakeholders, culminating in a comprehensive comparative evaluation.

Objective and Purpose

The legislative intent underpinning Clause 191, as with its predecessor provisions, is to ensure a fair and equitable tax regime for employees who participate in recognised provident funds. Provident funds are designed to promote retirement savings, and the tax system has historically provided significant incentives for such savings through exemptions and deductions. However, to prevent abuse of these incentives and to ensure that tax benefits accrue only to genuine long-term savings, the law stipulates conditions under which accumulated balances may be taxed.

Clause 191 specifically addresses circumstances where an employee's accumulated balance in a recognised provident fund becomes taxable because the exemption conditions (as set out in the corresponding schedule) are not satisfied. The provision ensures that such taxation is carried out in a manner that reflects what would have been the tax liability had the fund not enjoyed recognition status, thereby neutralizing any unwarranted tax advantage.

This approach is rooted in the policy rationale of balancing tax incentives for social security with revenue protection, and it reflects the historical evolution of provident fund taxation from the Indian Income-tax Act, 1922, through the 1961 Act, and now into the proposed 2025 Bill.

Detailed Analysis of Clause 191 of the Income Tax Bill, 2025

Key Elements

• Trigger for Taxation: The provision is triggered when the accumulated balance in a recognised provident fund is included in the employee's total income, i.e., when exemption under the relevant schedule is not available.
• Reference to Schedule: The clause refers to paragraph 8 (conditions for exemption) and paragraph 9 (mechanism for taxation) of Part A of Schedule XI (presumably the new equivalent of Schedule 04 of the 1961 Act).
• Role of Assessing Officer: The Assessing Officer is tasked with calculating the aggregate tax liability as per the prescribed mechanism.

Interpretational Considerations

Clause 191 is succinct, but its operation is contingent on the detailed rules in the relevant schedule (presumably mirroring the structure of the Fourth Schedule of the 1961 Act). The cross-reference system ensures that the provision is not self-contained, but operates in tandem with the detailed eligibility and computational rules set out in the schedule.

The phrase "owing to the provisions of paragraph 8 ... not being applicable" indicates that the default position is one of exemption, subject to satisfaction of certain conditions (e.g., minimum service period, reasons for cessation of service, transfer to another RPF, etc.). When these conditions are not met, the accumulated balance becomes taxable.

The computation mechanism-"calculate the total of the various sums of tax as per the provisions of paragraph 9"-suggests a retrospective application, requiring a notional recalculation of tax liabilities as if the fund had not been recognised. This is intended to recapture the tax benefit that would otherwise have accrued.

Section 111 of the Income-tax Act, 1961: Analysis and Comparison

Key Elements and Structure

• Trigger for Taxation: As with Clause 191, Section 111(1) is triggered when the exemption u/r 8 of Part A of the Fourth Schedule is not available.
• Computation: The Assessing Officer is required to compute the tax as per sub-rule (1) of rule 9 of the Fourth Schedule.
• Super-tax Provisions: Section 111(2) deals with super-tax in legacy cases where the accumulated balance is not included in total income but becomes payable, referring to sub-rule (2) of rule 9.

Comparison with Clause 191

• Substantive Parity: The operative mechanism of Clause 191 is substantially similar to Section 111(1), both in structure and effect. Both provisions are triggered by the non-applicability of the exemption rule, and both direct the Assessing Officer to calculate tax as per the relevant rules in the schedule.
• Reference to Schedules: The only material difference is the reference to the specific schedule and paragraphs (Schedule XI in the 2025 Bill versus the Fourth Schedule in the 1961 Act). This is a matter of drafting and reorganization rather than substantive change.
• Super-tax: Clause 191 does not explicitly mention super-tax, unlike Section 111(2). This may reflect the obsolescence of super-tax in the current tax regime or a deliberate policy choice to omit it from the new legislation.

Schedule 04 (Fourth Schedule), Part A: Recognised Provident Funds - Detailed Analysis

Overview of the Schedule

Part A of the Fourth Schedule to the 1961 Act sets out the detailed regulatory and tax framework for recognised provident funds. It covers definitions, conditions for recognition, computation of taxability, exemption provisions, and procedural rules. The key operative provisions for our purposes are rules 8 and 9.

Rule 8: Exclusion from Total Income of Accumulated Balance

Rule 8 provides that the accumulated balance due and becoming payable to an employee is to be excluded from total income if certain conditions are met, namely:

• Continuous service with employer for five years or more;
• Termination due to ill-health, employer's business closure, or other causes beyond the employee's control;
• On cessation of employment, if the accumulated balance is transferred to another recognised provident fund or to a pension scheme u/s 80CCD.

An explanation ensures that service under previous employers is counted for the five-year period if the balance is transferred.

Rule 9: Tax on Accumulated Balance

Rule 9(1) sets out the computational mechanism when the exemption u/r 8 is not available:

• The Assessing Officer must calculate the tax that would have been payable by the employee for each relevant year if the fund had not been a recognised provident fund.
• The excess of this aggregate over the actual tax paid is payable as tax in the year of payment of the accumulated balance.

Rule 9(2) deals with legacy super-tax issues, which are now largely academic.

Procedural and Compliance Provisions

Rule 10 mandates deduction at source by the trustees at the time of payment of accumulated balances, treating the payment as salary income for TDS purposes.

Practical Implications

For Employees

• Employees who do not satisfy the exemption conditions (e.g., who resign before five years of service for reasons not covered by the exceptions) will face tax on their accumulated balance.
• The tax liability is calculated retrospectively, as if the employer's contributions and interest thereon were taxable each year, thereby neutralizing the benefit of recognition.
• This can result in a significant tax outgo in the year of withdrawal, with potential cash flow and planning implications.

For Employers and Fund Trustees

• Trustees are required to withhold tax at source on the taxable portion of the accumulated balance, ensuring compliance and reporting under the TDS regime.
• Employers must maintain detailed records to facilitate retrospective tax computation and to respond to queries from tax authorities.

For Tax Authorities

• The Assessing Officer's role is critical in ensuring accurate computation, particularly in cases where employment history, transfers, or prior fund memberships complicate the calculation.
• The retrospective nature of the computation can pose administrative challenges, especially where records are incomplete or disputed.

Comparative Analysis: Clause 191, Section 111, and Schedule 04

Structural and Substantive Parity

Clause 191 of the Income Tax Bill, 2025 is, in essence, a restatement of the existing Section 111(1) of the 1961 Act, with updated cross-references to the relevant schedule. Both provisions are procedural gateways, directing the Assessing Officer to apply the computational mechanism set out in the relevant schedule (paragraph/rule 9) when the exemption (paragraph/rule 8) does not apply.

The substantive law-the conditions for exemption, the method of computation, and the procedural obligations-remains anchored in the schedule (Schedule XI in the 2025 Bill, Fourth Schedule in the 1961 Act).

Key Similarities

• Both provisions are triggered by the same factual matrix: non-fulfillment of exemption conditions for RPF withdrawals.
• Both direct the Assessing Officer to apply a notional computation, recalculating tax liabilities as if the fund had not been recognised.
• Both rely on the detailed rules in the schedule for operationalization.

Key Differences

• Super-tax: Section 111(2) and rule 9(2) of the Fourth Schedule deal with super-tax, a concept largely obsolete in the current regime. Clause 191 omits this, potentially reflecting legislative modernization.
• Drafting and Structure: Clause 191 is drafted with reference to Schedule XI rather than the Fourth Schedule, indicating a reorganization of the statute in the 2025 Bill. The substantive effect, however, is unchanged.
• Terminological Updates: The 2025 Bill may update terminology for clarity or modernization, but the core legal principles remain intact.

Potential Issues and Ambiguities

1. Complexity of Calculation

The retrospective, year-wise calculation of tax liability can be complex, particularly for employees with long service or multiple employers. Errors or disputes may arise over the computation of notional tax, the rate of tax to be applied for each year, and the treatment of interest and employer contributions.

2. Recordkeeping Challenges

Employers and trustees must maintain detailed records for each employee, sometimes over decades. Changes in tax law, salary structures, and fund rules over time can complicate this task.

3. Employee Awareness

Many employees may not be fully aware of the tax consequences of early withdrawal from an RPF. There is a need for greater education and transparency, possibly through mandatory disclosures at the time of joining and leaving employment.

4. Litigation Risks

Given the sums involved and the potential for calculation errors, disputes may arise between employees and the tax authorities, leading to litigation. The law provides for appeals, but the process can be lengthy and costly.

Conclusion

Clause 191 of the Income Tax Bill, 2025 represents a continuity of the existing legal framework governing the taxation of accumulated balances in recognised provident funds when exemption conditions are not met. The provision, together with the detailed rules in the relevant schedule, ensures that tax incentives for long-term savings are preserved for genuine cases, while preventing abuse through premature or non-qualifying withdrawals. The mechanism of retrospective tax computation, though administratively complex, is essential for maintaining the integrity of the tax system. The shift from Section 111 and the Fourth Schedule to Clause 191 and Schedule XI is primarily structural, reflecting legislative reorganization rather than substantive change. The omission of super-tax provisions in the new clause is a welcome modernization, aligning the law with current tax practice.

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Full Text:

Clause 191 Tax on accumulated balance of recognised provident fund.

 

Dated: 29-4-2025