InvestorQ : What could be the implications of the tax on ULIPs and PF funds put forth in the budget?
Rutuja Nigam made post

What could be the implications of the tax on ULIPs and PF funds put forth in the budget?

1 year ago

One of the very significant announcements in the Union Budget was pertaining to the interest tax limits for Provident Funds and for unit linked insurance plans or ULIPs. The government announced in the Union Budget 2021 that ULIPs and PFs that are of high value nature will enjoy lower tax benefits. The idea is to restrict tax arbitrage for HNI individuals.

Let us look at the two announcements in detail. Firstly, the budget had actually made interest on PF more than Rs.2.50 lakhs in a single financial taxable in the hands of the provident fund account holder. This will be applicable to contributory provident funds, especially for VPF where people contribute more. This will not apply to employer share.

Similarly, in the case of ULIPs, if annual premium paid on the ULIP is more than Rs.2.50 lakhs in one financial year then the difference between the investment made in the ULIP and the redemption value of the ULIPs will be treated as long term capital gains. This would discourage HNIs from using PFs and ULIPs only for getting tax-free income.

In the case of PF, the government is paying above market rates and also losing out on tax revenues. This way the government can at least plug some of the revenue leakages. It has been intriguing that repo rate has fallen to 4% but the coupon interest paid on most deposits is way much higher. The reason can be attributed to PF and small savings.

The reason was that the higher yields on PF combined with the tax benefits were making them just too attractive for the investors. Hence other interest rates could not fall below a point due to risk of losing business. The latest decision to impose tax on PF withdrawals beyond a threshold will be favorable for bonds as the yields can fall further lower.