What is the rationale behind taxing provident funds?

The Bangladesh government needs to reconsider the provisions imposing taxes on provident funds to ensure fairness and justice.After all, taxes are not compulsory.

The money that employees receive from their provident fund at the end of their working lives is one of the most important funds in retirement. This is especially true in countries like Bangladesh, where there is no social security system to support retirement.

Therefore, imposing a 30% (27.5% if certain conditions are met) tax on income from small retirement savings accumulated from employees’ salaries is not justified in the socio-economic context.

Provident Fund (PF) is an important retirement fund for private and public sector employees. Provident funds are generally built up through small contributions from employees’ salaries. Employers also contribute the same amount.

This fund is recognized as a provident fund as it requires approval from the NBR to obtain certain tax benefits. While leaving the company, the employee receives the accumulated contributions and the income that the fund has generated over the years.

This fund is entrusted with an employee trust established in accordance with the Trust Act, and is managed by a board of trustees consisting of management and employee representatives. Labor laws govern the investment and utilization of such funds.

As far as taxes are concerned, four aspects need to be considered.

First, should contributions made by an employer to a fund be treated as a recognized business expense for tax purposes?

Second, should the income generated each year in the employee’s account be taxed in the employee’s hands?

Third, should the amount received at the end of service be taxable? And finally, should the trust, which is a separate legal entity, pay tax on the income earned?

Under the Income Tax Ordinance, 1984, contributions by an employer to an employee’s provident fund were considered an allowable business expense. The company receives tax benefits from such expenses.

Similarly, the income accruing to the employee annually from the PF is primarily tax-free. Only income exceeding 14.5% of the investment amount or one-third of the basic salary (this cap is rarely achieved) was subject to tax at the employee’s individual tax rate.

The amount that employees and workers were receiving from PF at the end of their useful life was exempted from tax subject to approval status.

Although the aforementioned tax scenario is almost the same under the current Income Tax Act, 2023, there are significant changes regarding filing of tax returns by PF trusts.

Under the 1984 Ordinance, provident fund trusts were not required to file tax returns and such filing was voluntary. Therefore, the income generated by the PF Trust Fund as a separate legal entity was not taxable on any legal basis.

However, section 166(1) of the Income Tax Act 2023 provides a list of persons who are required to file a tax return and section 166(2) lists those who are not required to file such a return. is listed.

Government provident funds and pension funds are included in the exclusion list, but similar funds established by private sector workers and employees are not included in the exclusion list.

Section 166(1) provides that a person who is required to file a tax return under section 264 must file a tax return. Therefore, based on these provisions, PF trusts will be required to file tax returns under the new law.

The story doesn’t end there. The tax rate for such funds is set at the corporate tax rate, or 30%. Has anyone at the policy level ever thought about how, with the slightest stroke, 30% of his annual salary was taken away from the meager savings of a worker or employee in the private sector?

Naturally, questions may arise as to the rationality of such a tax. In countries where retirement is not supported by any social security system, there is no justification for taxing income from small retirement savings built from wages.

The question also arises as to how reasonable it is to impose a 30% tax on provident fund income. A worker who at the individual level is subject to 10% or 15% tax must pay 30% of his income indirectly through PF.

Another question is if civil servants receive similar income from the government provident fund, they remain exempt from tax.

Any taxpayer should wonder why such discriminatory treatment should exist between private and public employees. This violates the norms of tax fairness.

The Bangladesh government needs to reconsider the provisions imposing taxes on PF to ensure fairness and justice. After all, taxes cannot be collected by force.

Mr. Jamal Ahmed Chaudhry is a former president of the Bangladesh Institute of Cost Management Accountants.

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

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