Finance Minister Arun Jaitley’s proposal to tax the Employees Provident Fund came under stinging criticism from the leaders of central unions, who suggested that it’s a ploy to make the retirement benefit scheme unattractive for salaried workers.

The union leaders insinuated that Jaitley’s proposal is part of the Modi government’s determined effort to promote private sector financial products over Employees Provident Fund. Just last year, in his budget speech, the finance minister had declared that EPF has “hostages, rather than clients” and, furthermore, made it optional for employees to subscribe to it or to the National Pension Scheme.

Jaitley’s proposal, if implemented, will have two broad effects, the unions say. In the short run, it will act as “double tax” on workers’ earnings: first the income gets taxed and then the savings. And over the long term, it’ll expose workers’ retirement funds to greater market risk and volatility. Here’s how.

Driving workers away

Employees Provident Fund works as a savings instrument where a percentage of the salary is put aside into a fund. Workers contribute 12% of their basic salary towards the fund and employers match that amount, with the aggregated finally being placed with the Employee Provident Fund Organisation. The Organisation then invests the pooled money, generating interest and building a corpus for the employee. So far, the savings were tax-free at the time of the investment, on the earned interest, as well as at the time of withdrawal on maturing at age of 58 years.

In his 2016 budget speech, Jaitley proposed major changes to the functioning of EPF. He announced that, after April 1 this year, 40% of the provident fund withdrawal will be tax-free, implying that the remaining 60% will be taxed. This was a first since 1952. Jaitley rationalised that the idea was to bring EPF in line with the National Pension Scheme, a government savings vehicle launched in 2004.

There are some key differences between EPF and the National Pension Scheme.

First is the subscriber base. While EPF has 3.7 crore subscribers, the National Pension Scheme, which was launched as a compulsory saving scheme for government employees and then opened to all salaried workers, has 95.27 lakh subscribers. Just 9.7 lakh contributors joined it in the last fiscal year.

Second is the taxation. While EPF withdrawals aren’t taxed (so far), withdrawals from the National Pension Scheme are. Which is one reason for the pension scheme’s lesser popularity.

Third is the exposure to the volatile financial markets. The National Pension Scheme offers market-linked returns: up to 15% of the deposits contributed by central and state government employees and up to 50% of the deposits made by non-government workers can be invested in equity-related schemes and stock markets. In contrast, EPF offers its subscribers a high rate of return of 8.8% at very low risk since it’s not exposed to the stock markets. The Modi government has been trying to change this, though.

For the first time ever, the Labour Ministry invested 5% of the total EPF deposits of Rs 6.5 lakh crore in the equity markets last year, following a proposal in the 2015-’16 budget.

AK Padnamabhan, the president of the Centre of Indian Trade Unions and a member of the EPF central board of trustees, said that since last year the board had been opposing investment of provident fund in equity markets. “All members of the board had opposed the move to invest EPF contributions in equity because of risks in investing in financial markets. We wanted the government to tread cautiously and that is why, it was decided that only 5% of PF deposits will be invested.”

Last month, the Employee Provident Fund Organization had announced an increase in the rate of return on deposits from 8.75% to 8.8%, with Union Labour Minister Bandaru Duttatreya announcing that the organisation was in a position to even offer a rate of 9%.

“If the Provident Fund is stable, growing, and earning an income without going to financial markets, then why should crores of people’s retirement savings be exposed to risk?” Padmanabhan asked. “If the financial markets fall, and we have seen several such crashes recently, then who will be responsible for the vagaries of markets?”

The unions allege that by making EPF taxable, and unattractive, the government is driving salaried workers towards other savings instruments like the National Pension Scheme which, unlike EPF, are exposed to the markets. They have announced an all-India protest on March 10 to raise this and other issues related to workers’ welfare. They say the government's focus should be on ensuring provident fund coverage for all unorganized sector workers.

All India Trade Union Congress national secretary DL Sachdeva said the provident fund offers a low-risk saving scheme to crores of people.

Virjesh Upadhayay, general secretary of the Bhartiya Mazdoor Sangh, a wing of the Rashtriya Swayamsewak Sangh, and a member of the EPF board, said the union are in talks with the finance minister to withdraw the proposal of taxing EPF. Upadhayay declined to comment on the issue of investment in equity markets and said that for Bhartiya Mazdoor Sangh, the tax on withdrawals was the “only immediate and valid concern.”

Clarification didn’t help

After Jaitley’s budget proposal met with sharp criticism, the Finance Ministry clarified that even 60% of the withdrawal of EPF will not be taxed if the savings were invested in annuities. An annuity is an investment scheme that offers a monthly, quarterly or annual pension, but these are also subject to further tax. The ministry also clarified that the tax provision applied only to workers earning more than Rs 15,000 per month.

A senior official in the Employee Provident Fund Organization said the ministry’s statement may not change anything. “Since the finance minister in his speech used the term ‘corpus’ of contributions, only a legal provision withdrawing this provision will restore the status of provident funds to what it was so far,” said the official.

Commenting in the Business Standard, N Sundaresha Subramanian noted that the government’s proposal was silent on taxing private insurance products, which may have been a better measure to incentivise savings in the National Pension Scheme. The Indian Express reported that the push to salaried workers to invest in annuity products offered by insurance companies will likely provide a windfall to insurance companies.