What is the rationale behind taxing provident funds?

Illustration: TBS

Money that an employee receives from the provident fund at the end of their active services is one of the most critical resources after retirement. This is especially true for a country like Bangladesh, where no social security scheme supports life after retirement. 

Therefore, imposing a 30% (27.5% if certain conditions are fulfilled) tax on the income from employees' small retirement savings built from their salary is not justifiable in our socio-economic context. 

Provident fund (PF) is a vital retirement benefit for private and public sector employees. A provident fund, in general, is built up with the small contributions of the employees from their salaries. The employers also contribute an equal sum to it. 

This fund is recognised as a provident fund because approval is to be obtained from the NBR to get certain tax advantages. While retiring from the enterprise, an employee receives the cumulative contributions made and the earnings the fund generates over the years. 

The fund is vested with an employee trust established under the Trust Act, and the board of trustees, formed with the representatives of the management and the employees, manages the fund. The Labor Act specifies the investment and utilisation of such funds. 

As far as the tax is concerned, four aspects need to be considered. 

First, should the contribution made by the employer to the fund be treated as tax-approved business expenses? 

Second, should the income accruing to the employees' account every year be taxable in the hands of the employee? 

Third, should the amount received at the end of their services be taxable? And finally, should the trust, a separate legal entity, pay tax on the Income it earns? 

In the Income Tax Ordinance 1984, the contribution made by the employer to the employees' provident fund used to be considered an allowable business expense. The company gets tax benefits from such expenses. 

Similarly, income accruing to the employees each year from the PF is mainly outside their taxable income. Only income above 14.5% of investment or one-third of basic salary (a cap rarely achievable) was subject to tax in the hands of the employees at their individual tax rates. 

The amount the employees and the workers used to receive from the PF at the end of the service life was, subject to the recognition status, exempt from the tax.

Although the aforesaid tax scenario remains more or less the same in the current Income Tax Act 2023, there is a significant change regarding the submission of tax returns by a PF Trust. 

In the 1984 Ordinance, the provident fund trusts were not required to submit their tax return, any such submission was voluntary. Income generated by a PF Trust fund as a separate legal entity was thus not taxable on legal grounds. 

However, section 166 (1) of the Income Tax Act 2023 provides a list of those who must submit tax returns, while section 166 (2) states who are not required to make such submissions. 

Although government provident and pension funds have been included in the exclusion list, similar funds established by the workers and employees in the private sector are not. 

Section 166 (1) states that any person required to submit proof of return under section 264 must submit their tax return. Thus, under these provisions, a PF trust has to submit a tax return under the new Act.

The story does not end there. The tax rate for such a fund has been set to be the company rate, i.e., 30%. Has anyone at the policy level ever considered how a mild stroke of their pen has taken away 30% of the yearly income from small savings of the workers and employees in the private sector? 

Questions may reasonably be raised as to the rationality of such tax. In a country where life after retirement is unsupported by any social security scheme, taxing income from small retirement savings built from their salary is not justifiable. 

One can also ask how far it is rational to charge a 30% tax on the provident fund income. A worker in the 10% or 15% tax bracket at an individual level will have to pay 30% of their income through the PF indirectly. 

Another questionable point is that if a government employee earns similar income from a government provident fund, they remain outside the tax purview. 

Any taxpayer can ask why such discriminatory treatment should exist between private and public employees. This is against the canon of equity of tax.

The government of Bangladesh needs to reconsider the provision of imposing tax on the PF to ensure equity and justice. Tax is, after all, not a collection by force. 

Jamal Ahmed Choudhury is the former President of Bangladesh's Institute of Cost and Management Accountants.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.