NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), which has introduced partial withdrawals and premature exits, in order to align with the needs of the growing subscriber base.
Withdrawal from NPS is permitted by the PFRDA upon exit or closure at the time of maturity, partial withdrawal for specific purposes (such as higher education of children, marriage of children, purchase / construction of house / flat or for treatment of specified illnesses) etc. In these scenarios, subscribers are required to purchase annuity to a specified extent, depending on the type of withdrawal.
Where withdrawals are permitted by PFRDA, section 10(12A) of the Income -tax Act, 1961 provides for exemption of the withdrawal from NPS corpus. As per the PFRDA rules, a subscriber can withdraw maximum 60% as lumpsum and the remaining 40% must be mandatorily used for buying annuity. As per the income tax laws, lumpsum withdrawal of 60% of the corpus will be exempted from income tax. The remaining 40% (which is used for buying annuity plan) will be taxable when the annuity is received by the subscriber.
The rules for taxation of partial withdrawal from an NPS account are different. When a partial withdrawal is made from the NPS account, 25% of the individual’s contribution is exempted from income tax. The remaining is taxable under the head ‘Income from other sources’ at the income tax rate applicable to the subscriber’s income.
Recently, the PFRDA amended the rules for NPS withdrawal upon maturity, in order to allow individuals to withdraw 100% corpus as lumpsum, if the corpus value is Rs 5 lakh or less. However, there is no corresponding amendment to taxation in respect of the recent change of allowing 100% withdrawals where the corpus is less than Rs 5 lakh.
In other words, even though PFRDA permits 100% withdrawal of NPS corpus in certain cases on maturity, income tax exemption as of now does not extend beyond 60%. Hence, the remaining 40% of the corpus would be taxable in the hands of the individual upon withdrawal from NPS, even though 100% withdrawal as lumpsum is permitted by PFRDA in cases where corpus is equal to or less than Rs 5 lakh on maturity.
Suppose you have accumulated Rs 4.80 lakh as NPS corpus on maturity. As per PFRDA rules, you can take/withdraw 100% lumpsum on maturity but out of this, only Rs 2.88 lakh will be exempted from income tax. The remaining Rs 1.92 lakh will be taxable in your hands. It is important to note that there is no clarity on how to report the taxable portion that is received as lumpsum by an individual unlike in the case of partial withdrawals where this aspect is clarified.
Under the PFRDA rules, on maturity of his account, an individual (in cases where the accumulated maturity corpus is over Rs 5 lakh) has to mandatorily buy an annuity by paying a lumpsum amount to a life insurance company to receive the annuity (pension) for the agreed term period. The individual will only have to pay income tax on the annuity at the time of the receipt of the annuity payments.
One may note that Income-tax Act, 1961 has kept pace with changes in the statutory landscape. For instance, when the gratuity ceiling was enhanced from Rs 20 lakh under the payment of Gratuity Act 1972, corresponding changes were made to the Income Tax Act dealing with gratuity exemption. The change provided for increasing the gratuity exemption under the Income Tax Act, to Rs 20 lakh.
Accordingly, it can be reasonably expected that Budget 2023 might amend Section 10(12A) of the Act, thereby extending the tax benefit to 100% withdrawal where the corpus is less than Rs 5 lakhs. One will have to wait and watch.
(Views expressed are personal only. Sudhakar Sethuraman is Partner at Deloitte India and Vijayalakshmi Kartik is Manager at Deloitte Haskins & Sells LLP.)