On 18th August 2020, the Central Board of Direct Taxes has issued a list of guidelines that prescribe conditions for the pension funds in India to take the benefit of income tax exemptions.
The announcement comes after a July notification related to Draft Proposed Pension Fund Rules 2020 that intends to make amendments in giving benefit to pension funds, sovereign wealth funds and the Abu Dhabi Investment Authority from Income –Tax on the amount of received dividends and long term capital gains (LTCG) on debt or equity investments in prescribed 34 infrastructural sectors.
Therefore, the Central Board of Direct Taxes (CBDT) has endeavored to provide a proper framework through the fulfillment of certain conditions under which the pension funds could avail IT exclusions.
1. What does the notification state?
As per the notification, the following are the conditions proposed to be satisfied to avail tax exemptions through pension funds-
The pension funds will be allowed to avail tax exemptions on income gained through debt or equity investments in infrastructure companies, however, the income should not come from any commercial activity in India or overseas;
A. The pension fund must be administered in the region where it is founded and the proceeds acquired through the investments should be used solely for the purpose of providing pensions, social security doles like unemployment benefits, retirement benefits, employment, disability, death benefits, or similar compensation to participants, etc.
B. No portion of the proceeds or assets of the pension fund shall form part of income inures to any other private person;
C. Investment disclosures shall be accomplished in the prescribed formats in every quarter and filing income returns received from local investments has also been made compulsory.
2. What are Pension Funds in India? What purpose do they solve?
A pension plan is an instrument to secure a person’s financial stability post-retirement. These plans are maintained by the employers to protect his/her employees from uncertainties that may come unannounced post-retirement.
Similarly, pension plans are also popularly known as retirement plans and are also chosen by a person on a voluntary basis on his retirement. For this, a person invests some portion of his income into a designated plan to avail of a regular income after retirement.
Normally the pension plans in India work in two stages:
a. Accumulation stage and
b. Vesting stage
In the accumulation stage, an investor pays annual premiums until they reach their specified age of retirement. In the vesting stage, the pensioner shall receive monthly payments on a regular basis start until their death or the death of their nominee.
3. Tax implications on Pension Schemes-
Contributions made by an individual towards a pension plan are tax-exempt up to a maximum ceiling of rupees one lakh and fifty thousand(1,50,000/-) under Section 80CCC of the Income-Tax Act 1961. Such contributions also involve amounts expended on the purchase of a new pension plan or the renewal of an existing plan of similar nature.
The deduction is free to be availed by either residents or non-residents under except a Hindu Undivided Family under the provisions of Income Tax Act 1961.
Though the contributions are exempt from Income-tax Act are exempt up to a certain limit, but withdrawals are not tax-free.
Out of the total corpus, only one-third portion given to the pensioner under the pension plan is tax-free. The remaining portion is disseminated as an annuity and is subject to income-tax and reliant on the tax rate at the time of retirement.
4. Advantages of Pension Funds-
Some of the advantages of investing in Pension Plans are listed below:
A. Option to choose the right investment for the investor-
The Pension funds in India give an option to the investors to either invest in safe government securities or to achieve higher earnings by investing in private debt and equity investments on the basis of their risk profile.
B. The benefit of long-term savings-
Pension Funds provide guaranteed long-term savings to the investors depending upon the investor’s decisions whether he wants a lump sum payment or regular payments of small amounts, the savings are guaranteed.
C. Acts as a life insurance cover-
Normally, pension plans in India propose either a lump sum amount to the investor on retirement or on the death of the individual, whichever occurs earlier. Therefore, it acts as a life insurance cover.
D. Negates the influence of Inflation-
Pension funds assure to negate the influence of inflation by paying a lump sum at the time of retirement, which is equal to one-third of the amassed corpus and the outstanding two-thirds of the corpus is applied to generate stable cash flow.
E. Access emergency Funds-
Pension Funds permit the individual to adjust their pension policy by providing access to a lump- sum payout in emergency situations for instance as long-term health care etc.
5. Disadvantages of pension plans-
A. Fixed Celling of deduction allowed:
Though pension schemes succeed as a tax deduction amount, the maximum permissible deduction on life insurance premium is limited in Rs 1.5 lakh under the Income Tax Act, 1961.
B. Tax Deductions at the time of withdrawal:
Pension plans are subject to tax deductions on the receipt of the annuity after retirement.
C. Best suited for early investors:
Pension plans are better suited for investors in early ages to get a significant amount of returns. Though it is a safer and easier option to plan retirements, it may provide lesser returns to individuals who invest in their 30 or 35 years, as compared to those in their early 20’s to get a significant return.
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