The National Pension System (NPS) has two types of accounts: Tier I and Tier II. The level I account is the main account and is mandatory while opening a level II account is optional. The Level II account is like a savings bank account where you can deposit and withdraw money as and when you want. You can transfer money at any time from a level II account to a level I account and not the other way around. All subscribers are entitled to tax benefits for contributions made to the Level I account, but tax benefits for contributions to the Level II account are only available to central government employees with a three-year lock-in period. Since there are no specific provisions for the taxation of withdrawals from a Level II account under the law, I thought I will try to explain how these withdrawals should be taxed logically?
Are withdrawals from the Tier II account taxable?
In accordance with Article 10 (12A) of the Income Tax Law, 60% of the amount withdrawn at the closing or at the time of deregistration of the account referred to in Article 80 CCD is tax-free between hands of the underwriter. Likewise, during partial withdrawals, 25% of the subscriber’s contribution from the account referred to in article 80 CCD is tax-free in accordance with article 10 (12B). Implicit CCD article 80 refers only to the level I account because the deduction under this article is only available for contributions to the level I account and not for contributions made to the level II account for which the deduction is available under Section 80C (2) (xxv).
There is no specific and direct provision for the taxation of withdrawals from a Level II account under the Income Tax Act. If the tax legislation does not contain specific provisions for the taxation of an item, it does not become by default exempt from tax or taxable. In such a situation, you have to apply logic and rely on other provisions of the same law. The full value of the money withdrawn from the Level II account cannot be taxed, as lawmakers would not have considered imposing something at the time of withdrawal if no tax benefit had ever been claimed when the money has been dropped. But that doesn’t mean that the entire amount withdrawn would be tax-exempt. Withdrawals from the Tier II account are like regular withdrawals from your savings bank account, which are not taxed except to the extent of interest earned.
To arrive at the logical rules for taxing level II account withdrawals, I rely on the provisions of section 80CCC. Section 80CCC (1) provides for the deduction of the premium paid to purchase an annuity. Section 80 CCC (2) provides for the taxation of the cash surrender value of such a policy, which limits taxation to the extent that the tax benefits under section 80 CCC (1) have been claimed. by the individual and not beyond, except the increase of the investment. The same logic must be applied here.
How withdrawals should logically be taxed
For the reasons explained above, I am convinced that not all money withdrawn from the Level II account can be taxed by any stretch of the imagination. What can and should logically be imposed is the appreciation, if any, of the value of investments as included in withdrawals.
Since the investment made in the Tier II account does not have any fixed rate of return like fixed deposits or bonds or bonds, the appreciation in value of investments cannot be taxed under the heading “Income from other sources “. As a subscriber, units are allocated. for its investments in different fund categories like stocks, corporate bonds and government securities at their net asset value (NAV) at the time of investment, it makes sense to treat the contribution to the account level II as investments and to treat all profits thereon as earned capital.
Since investment in NPS cannot be called publicly traded stocks or be treated as shares of equity mutual funds, it will only become long term if the shares are sold after 36 months. Since the Securities Transaction Tax (STT) is not paid at the time of redemption, it cannot be taxed like stock-based regimes under Section 112A, even with respect to the equity component. It is taxed at a flat rate of 20% after indexation if it has been held for more than 36 months. If the units are redeemed within 36 months, the redemption profits should be treated as short-term capital gains and included in your regular income which will be taxed at the slab rate applicable to your total income.
The difference between the purchase and redemption NAV should be multiplied by the number of units used for redemption to get the profit made on redeeming a specific transaction.
Please note that all I have mentioned is not the exact legal position in the absence of a specific and direct provision in the Income Tax Act, but is purely my opinion obtained with the help of the voucher sense and logic. Given the confusion surrounding the tax on withdrawals for the Tier II account, it is the government’s duty to clarify the legal situation as soon as possible. This will help many people to make the decision to take advantage of the low cost investment avenue of the Level II account.
Balwant Jain is a tax and investment expert and can be contacted at [email protected]
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