7 steps to preventing EPF abuse

Indian Express, 20 July 2004

Clearly, the system is screaming for a change. It is important that membership of EPF is restricted to reduce the amount of subsidy. Recent data released by the EPFO suggests that 85 percent of the subsidy goes to those who don’t need the subsidy. There is no political or humanitarian excuse for this.

How can the subsidy be reduced?

There are two elements of subsidy to the EPF. The first is the subsidy due to paying 8 per cent rate on Special Deposit Scheme (SDS), as against 5.6 per cent on government bonds. This subsidy works out to around Rs 1200 crore.

The second element of subsidy is that due to tax exemptions given to the scheme.

Currently, income that goes into EPF is exempt from taxation, as is the interest and the final settlement.

This makes it attractive to high-salaried individuals, who join in even though they are not mandated to. Moreover, EPFO allows them to put amounts greater than the mandated amount of 12 per cent of basic salary into the scheme. This means they are able to grab the bulk of the subsidy.

This way only 15 percent of the subsidy goes to those who are mandatory members of the EPF. The subsidy for them through the interest on SDS is limited to about Rs 200 crore. Also, the tax rebate matters little to them.

The government should reduce the total subsidy it pays to EPF—for this, the following can be done:

The tax treatment of EPF should be changed. Income would be exempt when deposited in EPO. The interest earned would also be exempt and tax would have to be paid only when the final withdrawal is made. This would make the scheme less attractive to those who are using it to avoid tax.

Existing balances could stay under the system now in operation while any further money coming in could eventually be taxed on withdrawal.

No voluntary membership of EPF should be allowed. Only those with incomes up to Rs 6,500 a month are mandatory members. This ceiling can be reviewed, but all new members from now should only be those who fall in this category.

For current members, a reasonable monthly ceiling should be imposed on the amount that can be deposited per month. This will prevent misuse of the scheme. The subsidy will go to the poor.

A ceiling should also be imposed on the total amount that can be held in an EPF account. High net worth individuals should be not be allowed to be members of the scheme. Loopholes should be plugged so that each member has openly a single, unique EPF account and does not try to get around a ceiling by opening a new one each time he changes an employer.

The interest rate on EPF should henceforth be declared at the end of the year depending on what has actually been earned on investments.

The EPF Act should be amended to bring EPFO under the regulation of the new PFRDA.

Ila Patnaik