Scores of Indians who use the Public Provident Fund as a tax saving tool might now need to maintain three separate accounts instead of just one, as they now do, tax lawyers say.
Since 1968, all contributions, interest as well as any withdrawals have been non-taxable under the PPF saving plan. This plan is very popular among tax savers, with total contributions exceeding Rs 50,000 crore (Rs 500 billion).
But the government has decided to tax PPF withdrawals made after April 1. Under the proposed new tax model (Exempt Exempt Tax), while contributions and the interest earned on them will not be taxed, withdrawals will fall in the tax net if a tax deduction had been claimed on the contribution.
Essentially this means that any amount claimed as a deduction at the time of depositing the money in the PPF from April 1 will be taxed when it is withdrawn.
The problem that will crop up is that it will be difficult to determine which are past deposits, the interest earned on deposits and the fresh contributions. This could result in a spate of litigation, some tax lawyers argue.
"How will the income tax department be able to differentiate whether a withdrawal made after April 1 comes from contributions made prior to or after the date," asks advocate Prakash Jotwani.
The government may thus have to ask individuals to hold three separate accounts in order to clear matters and avoid litigation.
A separate account for crediting interest is necessary since the returns on PPF are tax exempt. Confusion could result if an individual withdrawing funds states that the money is from the interest component.
"Should the contribution and interest earned be in a single account as is the practice today, it would be difficult to identify whether the funds being withdrawn are from the interest portion or from the actual contribution made to the plan," says Jotwani.
Though the proposal to follow the EET model will become applicable to other forms of investment, it is only in the case of PPF that discrepancies can arise. In the case of national savings certificates, the principle and interest can be differentiated; likewise in the case of infrastructure bonds.
PPF on the other hand works on the lines of a bank account, where fresh deposits are today made in the same account, year after year. Only by opening three separate accounts can the government and tax authorities ensure clarity and avoid litigation.