DTC changes may spruce up NPS

     Print Edition: December 2012

The National Pension System (NPS), designed to solve the problem of post-retirement income security, is a combination of systematic investment and pension planning to help individuals plan for their future.

NPS has a unique feature wherein subscribers can plan their investments according to their age and risk appetite.

Vineet Agarwal, director of KPMG
Vineet Agarwal, director of KPMG
A subscriber has the flexibility of making contributions on a systematic basis, that is, monthly, quarterly or annual. Another key feature of the product is its low cost compared to other similar options. However, despite low cost and flexibility, tax benefits and implications of NPS will decide how attractive it can be for investors in the long run.

Like any other pension plan, contributions made by an individual are eligible for a maximum annual deduction of Rs 1 lakh under Section 80CCD of the Income Tax Act, 1961 (I-T Act).

But what sets it apart from other pension schemes is the tax benefit it offers under Section 80CCD(2) of the I-T Act. Under this Act, contributions made by the employer up to 10% of the basic salary and dearness allowance towards NPS qualify for deduction in the employee's hands. The employer is also eligible for a corporate tax deduction on this contribution.

Hence, individuals in the higher tax bracket can save significant taxes.

As these changes are beneficial to both employers and employees; some employers have started offering NPS as part of the compensation structure.

Let's understand it with an example. Shyam is a software engineer whose annual salary is Rs 20 lakh. His employer contributes 10% of the salary, that is, Rs 2 lakh, to NPS and Shyam makes a matching contribution.

>> Shyam will be eligible to claim a maximum deduction of Rs 1 lakh out of his Rs 2 lakh contribution.
>> Employer's contribution of Rs 2 lakh will be eligible for deduction and hence will not be taxable for Shyam.
>> Employer will be eligible to claim Rs 2 lakh contribution as a corporate tax deduction. This is in addition to Shyam's salary.

TAX AT WITHDRAWAL?

NPS requires you to compulsorily purchase an annuity so that you get some money in lump sum and the balance in annuity. Broadly, the lump sum and annuity are both taxable under the I-T Act as NPS follows an Exempt-Exempt-Taxable (EET) concept.

Under the proposed Direct Taxes Code (DTC), NPS will be covered under the Exempt-Exempt-Exempt (EEE) regime, wherein the investor will enjoy tax benefits when contributions are made.

The accumulations to the fund will continue to be taxfree; withdrawals from the fund are proposed to be exempt.

However, there is confusion if along with lump-sum withdrawal, earning from annuity (which is mandatory under NPS) will also be tax-free.

Schedule Six of the proposed DTC provides a list of income which will not be included in the total income of an individual, and it includes "any payment from New Pension System Trust to an employee having an account with the Trust under the New Pension Scheme notified by the Central Government."

Based on this reading, we can say that both lumpsum withdrawal and annuity are exempt from tax. However, it will be difficult to mention anything conclusive till DTC is finally implemented.

As withdrawals are likely to happen in the DTC era for most of the people, NPS can become an attractive investment opportunity, putting it on a par with other investment avenues.

Vineet Agarwal
Director, KPMG

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