National Pension System (NPS), a low-cost retirement product, was introduced by the government to help people accumulate corpus for their retirement. One can open two accounts as per the NPS structure; Tier I and Tier II. Tier I is also called pension account and is the main retirement account which is mandatory. Tier II is like a savings account to park your surplus money which you can withdraw anytime and is optional. You can transfer money from Tier II account to Tier I account and not vice versa. Although tax benefits for contributions to Tier I account are available to all customers, deduction for Tier II contributions is available only to central government employees with a lock-in-period of three years. The taxation rules for Tier I account are clear but no one is clear about the taxation of withdrawals from Tier II account. In this article I want to explain how withdrawals from Tier II account should be taxed.
Should withdrawals from Tier II account be fully taxable?
As per Section 10(12A) of the Income Tax Act, there is an exemption of up to 60% on account closure or exit from the scheme specified in section 80CCD. For the remaining 40% you will have to buy an annuity. Similarly, as per section 10(12B), 25% of the contribution made by you from the scheme referred to in section 80CCD is exempted from partial withdrawal. Since the deduction is available only for contributions made in Tier I account, section 80CCD by implication refers only to Tier I account and not to Tier II account. Further, Section 80C(2)(xxv), which allows deduction to a Central Government employee, specifically refers to Tier II account.
No law can predict and provide for all possible circumstances. If there is no provision for taxation on any particular commodity, then such article will have to be taxed using reason and common sense. If no tax benefit is claimed on the contribution, then by simple logic the entire amount received on maturity or withdrawal cannot be taxed. In my opinion, since Tier II account is like your savings bank account where you are allowed to make deposits and withdrawals as you wish, it is only accretion to Tier II account, like interest on savings bank account, to be taxed only and not the full amount.
I support my argument from the legal provisions for deduction of annuity under section 80CCC. An individual can claim deduction under section 80CCC(1) on the premium paid for purchasing an annuity. When a person surrenders the annuity policy, the taxation of such surrender value depends on whether the person had availed the deduction under section 80CCC(1) or not. If tax benefit was claimed, then the entire amount received on surrender of the annuity policy is taxed, but if no deduction is claimed, then only the increase in premium paid is taxed. Similarly, since no deduction is generally available for contributions to a Tier II account, only the appreciation in the amount of your contribution should be taxed and not the full amount of withdrawals during or after the currency of the account is closed. on the amount.
Under which head of income, appreciation should be taxed?
Based on the above discussion, it becomes clear that no withdrawals from Tier II account can be envisaged, but withdrawals can be taxed only on the amount of appreciation. Since the contribution made to the NPS Tier II account does not give you a fixed rate of return like fixed deposits or bonds or debentures, the difference amount cannot be taxed as interest under the head “Income from other sources”.
When you contribute to Tier I and Tier II account, you are allotted a specific number of units under different categories such as Equity and Debt, based on the Net Asset Value (NAV) as on the date of contribution, the contribution made is an investment. There is nothing other than that. Thus a capital asset in my humble opinion.
When you withdraw, a specific number of units are redeemed. So contributions and withdrawals work the same way as investments and redemptions of mutual funds. The difference between the NAV of the date of contribution and the date of withdrawal should be multiplied by the number of units to be used for redemption to arrive at the profit received on withdrawal.
Since investments in NPS can be classified neither as listed equity shares nor as units of equity mutual funds, your contribution becomes long term only after 36 months. Further, since no Securities Transaction Tax (STT) is levied by the pension fund manager on the withdrawal amount, your equity component also cannot be taxed under section 111A or 112A as equity oriented schemes. could. Hence, long-term capital gains will be taxed at flat 20% after indexation if held for more than 36 months and short-term capital gains are added to your other income and taxed at slab rates.
I would like to reiterate that everything explained here is not strictly as per legal provision as there is none under Income Tax Act but my personal opinion based on common sense. Given the confusion surrounding tax on withdrawals from Tier II accounts, the government should ideally clarify the legal position at the earliest. This will help many people decide to take advantage of the low cost investment avenue.
Balwant Jain is a Tax and Investment Specialist and can be reached at jainbalwant@gmail.com and @jainbalwant on Twitter.
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