Clarification needed on taxation of withdrawals

The National Pension System (NPS), a low-cost pension product, was introduced by the government to help people accumulate capital for their retirement. According to the NPS structure, one can open two accounts; Level I and Level II. Tier I is also called a retirement account and is the main mandatory retirement account. Level II is like a savings account to store your excess funds which you can withdraw at any time and which is optional. You can transfer money from a Level II account to a Level I account and not vice versa. While the tax benefits for Tier I account contribution are available to all subscribers, the Tier II contribution deduction is only available to central government employees with a three-year lock-in period. The taxation rules for the Level I account are clear, but there are no specifics on the taxation of withdrawals from the Level II account. In this article, I want to explain how the withdrawal from the Level II account should be taxed.

Should withdrawals from the Tier II account be fully taxable?

Pursuant to Section 10(12A) of the Income Tax Act, withdrawals from the scheme referred to in Section 80CCD are exempt up to 60% upon closure of the account or upon de-registration from the scheme . For the 40% balance, you must purchase an annuity. Similarly, in accordance with Section 10 (12B), 25% of the contribution you have made to the scheme referred to in Section 80CCD is exempt in the event of a partial withdrawal. Since the deduction is only available for contributions made to the Level I account, section 80CCD only implicitly refers to the Level I account and not the Level II account. In addition, section 80C(2)(xxv), which allows the deduction for central government employees, makes specific reference to the Level II account.

No law can foresee and provide for all possible circumstances. If there is no provision for the taxation of a specific item, that item should be taxed by applying logic and common sense. If no tax benefit is claimed on the contributions, by simple logic the entire amount collected at maturity or withdrawal is not taxable. In my opinion, since the level II account is like your savings bank account where you are allowed to deposit and withdraw as and when you want, only the accumulation in the level II account, such as interest on the savings bank account, should only be taxed and not the full amount.

I base my logic on the legal provisions relating to the deduction of annuities under article 80CCC. A deduction for the premium paid to purchase an annuity may be claimed under section 80CCC(1). Where a person surrenders the annuity policy, the taxation of that cash value depends on whether or not the person has benefited from the deduction under Section 80CCC(1). In the event that a tax benefit has been claimed, the entire amount received upon surrender of the annuity policy is taxed, but in the event that no deduction has been claimed, only the increase in the premium paid is taxed. . Similarly, since no Tier II account contribution deductions are generally available, only the appreciation on the amount of your contributions should be taxed and not the full amount of the withdrawal during the currency of the account or at its closing.

Under which head of income should the capital gain be taxed?

Based on the discussion above, it becomes clear that, without a stretch of the imagination, all of the money withdrawn from the Level II account can be taxed, but only the amount of appreciation can be taxed on the withdrawals. Since the contribution paid to the NPS Tier II account does not earn you any fixed rate of return such as fixed deposits, bonds or debentures, the differential amount cannot be taxed as interest under the heading “Income from ‘other sources’.

When you contribute to a Level I and Level II account, you are allocated a specific number of units in various categories such as equity and debt based on the net asset value (NAV) on the date of the contribution, the contribution made is nothing more than an investment and therefore a capital asset in my humble opinion.

When you withdraw money, a specific number of units are redeemed. Thus, contributions and withdrawals work on the same line as mutual fund investments and redemptions. The difference between the net asset value on the date of contribution and the date of withdrawal must be multiplied by the number of units used for the redemption to arrive at the profit made on the withdrawal.

Since the investment in NPS cannot be categorized into listed shares or equity mutual fund shares, your contribution only becomes sustainable after 36 months. Additionally, since no Securities Transaction Tax (STT) is levied by the pension fund manager on the amount of the withdrawal, it cannot be taxed under Section 111A or 112A. , as equity-based plans, even when it comes to your equity component. Therefore, long-term capital gains will be taxed at 20% after indexation if held for more than 36 months and short-term capital gains added to your other income and taxed at slab rates.

Let me repeat that everything explained here is not strictly in accordance with the statutory provision as there is none under the Income Tax Act but is just my opinion personal common sense. Given the confusion surrounding the tax on Tier II account withdrawals, the government should ideally clarify legal positions as soon as possible. This will help many people make the decision to take advantage of the benefits of a low cost investment avenue.

Balwant Jain is a tax and investment expert and can be contacted at [email protected] and @jainbalwant on Twitter.

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