It is just as well that the Government has decided that it will withdraw its proposal in the latest Budget, to tax a portion (60 per cent) of accumulated provident fund balance of an employee upon retirement/resignation, if it was not used to purchase an annuity.
The proposal generated so much controversy that the Government has been forced to beat a hasty retreat. Which is just as well. For the language in the Finance Bill, taken together with other relevant provisions of income-tax law, renders it vulnerable to a successful legal challenge, even otherwise. Here is why.
The subject of taxation in the instant case is the ‘accumulated balance’ of provident fund contributions lying to the credit of an employee. The law, as it stands now, grants exemption from tax for the entire sum of such ‘accumulated balance’, whenever it becomes due for payment. Now, the term ‘accumulated balance’ has a specific meaning under the I-T Act. This is an aggregate of the sum of employee and employer's contributions together with the accrued interest thereon.
Part of own contribution
Since the Bill makes no distinction between employee’s and employer's contribution for tax purposes, an employee-taxpayer is entitled to argue that what is being taxed is a portion of his own contribution, which makes up the 'accumulated balance'.
No doubt, an employee's contribution does enjoy some tax concession in the form of deductions from the 'Total Income' (the aggregate of income derived by an individual from all possible sources). In other words, the sum which represents an employee's contribution has already been recognised as part of an employee's total income and assessed to tax.
While in spirit the employee's contribution does enjoy shelter from taxation, in letter it cannot be denied that the salary receipts flowing into the accumulated balance as employee's contribution have already been recognised as income. It is a fundamental principle of taxation that no receipt can be assessed to tax in more than one year.
Non-refundable loans
That is not all. There is another problem. The contemplated provision in the Finance Bill does not treat all employees in an equitable manner. It is common practice among employees to avail of non-refundable loan out of the ‘accumulated balance’ standing to their credit for such purposes as constructing a house or for performing the wedding of a child or even payment of premiums on life insurance policies.
In all such cases the accumulated balance would be substantially lower (hence the amount of tax) than an employee who did not avail of any non-refundable loan but intended to deploy it for such a purpose after retirement. This is another infirmity from judicial standpoint.
Needless to say, it would not be possible to deny the privilege of non-refundable loan for such purposes such as house construction or children's wedding which has been a feature of social security architecture in India for decades.
Why was it introduced?
The surprising aspect is not that this controversial proposal has been withdrawn. Why was it introduced in the first place? It cannot be the prospect of a large revenue flow from such a proposal. The entire set of proposals on Direct Taxes front was supposed to yield a net sum of ₹1,000 crore. For a Union Budget with a resource base in excess of ₹15 lakh crore annually, that is just a round-off error in calculations.
The same goes for taxation of dividend incomes in excess of ₹10 lakh which are, until now, exempt in the hands of the recipients. Not only would the company be paying tax on the dividend distributed but recipients such as Azim Premji and Mukesh Ambani with the prospect of a large sum of money as dividend would have to cough up extra tax. The revenue impact for the Government would be minimal. But these levies taken together with large outlays which are expected to benefit the rural masses bear an element of political symbolism.
As a politician, if you are courting the rural voters you should not only cultivate an image of being pro-poor but additionally it wouldn’t hurt to acquire the image being not too favourably disposed toward the relatively well-off sections of the society. The EPF tax proposal or the taxation of dividends in the higher income-brackets is designed to do just that.
Interestingly enough, there is evidence in support of such a proposition from management theory on employee motivation. Whether you are a manager responsible for the output of a group of people under your charge or a politician wanting voters to respond favourably to your candidature, it boils down to this: How to get the people to modify their behaviour that suits one’s interests?
If you are a manager you would want your employees to give off their best so that the enterprise prospers. On the other hand, if you are a politician you would want the public to vote for your party in general and your own candidature in particular.
Herzberg’s theory
In an insightful essay on the subject, Frederick Herzberg, a noted behavioural theorist noted that behaviour goes through a two-stage process of change for the better. There are elements in the work environment such as poor salary, lack of proper canteen facility, and so on, which demoralise the worker to a point where he doesn’t feel enthused to give of his best. But as Herzberg pointed out, this in itself doesn’t contribute to altering worker behaviour.
A sense of job satisfaction at having done something that is mentally so stimulating or its recognition by the seniors at the work place, are aspects that truly motivate an employee to give of his best.
Perhaps so it is with voters. They too go through a two-stage process of altered behaviour by the actions of politicians. Being seen as anti-rich (hygiene factors, in Herzberg’s framework) doesn’t help much in garnering votes. But coupled with a set of ‘pro-poor’ policies (content factors) it just might help effect that decisive shift in behaviour.