All Indian citizens, whether resident or non-resident, aged between 18 to 70 years (as on the date of submission of NPS application) can join NPS. Further, even the employer of an individual can contribute certain sum of money each month to the NPS fund from the employee’s salary.
There are certain income tax implications of the contribution made to the NPS. Taxpayers can avail tax deductions on contributions made by the employer as well as their own contribution. There are certain expectations from Budget 2023 to provide income tax reliefs for NPS investments for private sector employees as discussed below.
Existing income tax deductions available on NPS contributionsGiven below are the current income tax deductions available on the contribution made by employer as well as employee towards NPS:
- Tax deduction with respect to employee’s contribution
Any employee contributing to NPS would be eligible to claim deduction under section 80CCD (1) of the Income Tax Act, 1961. Such deduction is firstly restricted to 10% of the (bBasic salary plus dDearness allowance) of an employee and further subjected to the threshold limit of Rs 1.5 lakh.
For example, an individual having basic salary of Rs 5 lakh in a year is eligible to claim deduction up to Rs 50,000 (10% of Rs 5 lakh) under section 80CCD (1) or the amount contributed towards NPS, whichever is less.
As aforementioned, the maximum deduction which can be claimed by any employee with respect to their NPS contribution is Rs. 1.5 lakhs. It is pertinent to note that the said threshold limit of Rs. 1.5 lakhs is a combined limit for specified investment linked deductions u/s 80C of the IT Act, contribution to certain pension fund u/s 80CCC of the IT Act and employee’s NPS contribution u/s 80CCD(1). Hence, to fully utilise the deduction of Rs 1.5 lakh, an employee will have to invest the balance amount in other specified avenues such as Employees’ Provident Fund (EPF), Public Provident Fund (PPF), etc.
Further, the employee is eligible to claim deduction under section 80CCD(1B) of the Income-tax Act. This deduction is available with respect to NPS contribution of Rs 50,000 over and above the threshold limit of Rs 1.5 lakh as aforementioned.
- Income tax deduction with respect to employer’s contribution to NPS
Regarding the employer’s contribution, the NPS contribution made by employer would first be taxable under the head ‘Salary’ in the hands of the employee and thereafter the employee can claim deduction u/s 80CCD (2) of the Income-tax Act. Such deduction would be restricted to 10% of the (basic salary plus dearness allowance) in case of private sector employees and to 14% of the salary in case of central as well as state government employees.
In order to curb the high salaried taxpayers from taking undue income tax benefit of NPS deduction by structuring their salary packages, a combined upper limit of Rs. 7.5 lakh per annum was made applicable from April 1, 2020. This limit of Rs 7.5 lakh also includes employer’s contribution to the provident fund and approved superannuation funds, apart from NPS.
According to the amendment made in the Income-tax Act under section 17(2)(vii), any excess contribution above Rs 7.5 lakhs in a year by an employer to EPF, NPS and superannuation fund was made taxable in the hands of the employee as ‘perquisite’. Also, any annual accretion by way of interest, dividend or any other amount of similar nature credited to such fund on the excess contribution was also taxed under section 17(2)(viia) of the Income-tax Act in the hands of the employee.
Expectations from Budget 2023
Prior to the Budget 2022, the enhanced deduction on employer’s contribution to NPS of 14% of basic salary under section 80CCD (2) of the Income-tax Act was only available to central government employees. However, the Budget 2022 specifically provided for such enhanced deduction to be made applicable to state government employees as well.
However, there has been no similar increase in the limit on claiming deduction in case of private sector employees. Thus, the private sector employees can only claim up to maximum 10% of their salary as a deduction with regards to contribution made by them towards NPS.
Having a different rate for deduction for government and private employees results in unequal treatment. As a result, the private sector employees may be less motivated to choose NPS as an investment option for retirement savings.
Accordingly, the government should enhance such deduction under section 80CCD(2) of the Income-tax Act from 10% to 14% for private sector employees as well and bring them on par with Central and State government employees.
This would not only enable the private sector employees to benefit from NPS but also encourage them to make social security contributions. Increasing the limit will also boost the habit of saving for retirement among the citizens and result in accumulation of long-term corpus for retirement.