I – FACTS

Your Company has established Provident Fund (“the Fund”), which is also
recognized by Commissioner of Income Tax (“the CIT”).

The Fund has members who, after leaving your employment, have not withdrawn
the balances to their credit lying with the Fund, on which, interest is being credited
as per the Rules of the Fund.

II – QUERY

Whether the accumulated balance in the account of the employees who have
already left the organisation and have retained their balances with the Trust, should
be disbursed after withholding tax therefrom?

III – REPLY

Though the Rules of your Fund need to be examined, normally, such Rules are as
follows:

 Member of the Fund shall continue to be a member until he withdraws the

amount standing to his credit in the Fund.

 Employee who is a member of the Fund shall not cease to be a member

thereof on his leaving the Company till his Provident Fund account is finally
settled.

 Interest earned by the Fund during the year shall be credited to the accounts
of individual members pro-rata on December 31 of each year, such interest
to be payable upto last day of the month preceding the month in which
member’s claim is settled.

 The circumstances in which and the events on the happening of which the
amounts standing to the credit of a member become payable are also laid
down in the Rules.

 Trustees, at the time the accumulated balance due to a member is paid, are
to deduct therefrom any income tax and super tax payable by the member
and that provision of Chapter XVII B of the Income Tax Act, 1961 shall apply,
as if the accumulated balances were income chargeable under the head
“salaries”.
Rule 6 of Part A of the Fourth Schedule to the Act prescribes that the portion of the
annual accretion in any previous year to the balance at the credit of an employee
participating in a recognised Provident Fund as consists of interest credited on the
balance to the credit of the employee in so far as it is allowed at a rate exceeding
such rate as may be fixed by the Central Government in this behalf by a notification
in the Official Gazette shall be deemed to have been received by the employee for
that previous year and shall be included in his total income for that previous year
and shall be liable to income tax.

While it is true that your Fund has credited interest to the accounts of the individual
members who are not currently in the employment of the Company as per the
Rules and Regulations of the Fund, the taxability or otherwise thereof is to be
determined in terms of the provisions of the aforesaid Rule 6. In other words,
interest credited in excess of the rate fixed by the Central Government (“the
specified rate”) as prevalent from year to year is to be considered as taxable
income of the employee in the respective year and obviously, the interest credited
upto the rate notified would not be taxable.

However, it is important to note here that the reference in the aforesaid Rule 6 is to
an “employee participating in a recognised Provident Fund”. Now, “Employee” has
been defined in Part A of the Fourth Schedule to mean “ an employee participating
in a Provident Fund but does not include a personal or domestic servant”.
Therefore, a question arises as to whether the ex-employees would be considered
within the meaning of the term `employee’ for the purposes of this Rule. In our
opinion, after leaving the service, the relationship between the two does not remain
to be that of that master and servant and hence, even though an individual
continues to be the member of the Fund he is continuing not in the capacity of an
employee and accordingly, would not get any benefit under Rule 6.

Thus, in our opinion, whenever an individual who is no longer employee of the

Company, but continue to be a member of the Fund, the interest received not only
in the excess of the specified rate of interest but even the interest credited upto the
specified rate would also be taxable in the hands of such ex-employee, the number
of years service put in by the said individual also would not be relevant.
Consequently, the trustees would be under obligation to deduct tax at source in
respect of the income credited to such members.

A question may arise that under which provisions of the Act, the tax is deducted at
source. In our view, since the amount credited to the balance in ex-employees’
account is nothing but interest other than interest on securities, the trustees would
be required to deduct tax at source at an appropriate rate as per section 194A of
the Act. This view is also confirmed by a recent decision, wherein it has been of
Hon’ble Delhi Tribunal in the case M/s ONGC Ltd. v. ITO (TDS), Dehradun, held that
if membership is continued in the absence of the employment with the entity who
constitutes and maintains the Fund and neither the conditions in clause (ii) and (iii)
of Rule 8 of part A of Fourth Schedule are fulfilled, any payment due from such a
Fund would not acquire the character of “salaries” for the purpose of the Act. Such
amount of interest credited by the Fund, therefore, is not liable to be taxed under
the head “Salaries” and the same is nothing but interest liable to be deducted at
source u/s. 194A of the Act.

We also draw your attention to Rule 5(3) of Part A of Fourth Schedule according to
which the trustees may, at the request by the employee, who ceases to be an
employee of the employer maintaining the fund, consent to retain the whole or any
part of the balance due to the employee, provided that such request is made in
writing. It is probable that this request may not have come from these ex-
employees at the time of their leaving or cessation of the employment, and
therefore, the trustee may ask them to withdraw the amounts due to them.