How to save tax by investing in NPS

Investment in National Pension System (NPS) has been a trending topic of discussion in the recent years from a tax saving perspective for individual taxpayers, considering various changes in the income tax laws. Tax benefits are available in respect of contributions to NPS made by the employer as well as employee / self-employed person to the NPS Tier 1 account. The tax benefits at the stage of contributions are summarised below:Employee contributionsSection 80CCD(1) of the Income-tax Act, 1961 provides deduction in respect of contributions made by an individual taxpayer towards NPS. An individual who has deposited any amount in his/her NPS account during the financial year is allowed to claim deduction from his/her gross income limited to 10% of basic salary for salaried individuals and 20% of gross total income for self-employed individuals. This deduction is for contributions made by the individual either directly or through the employer, i.e., as deduction from salary. However, the deduction available under this section is also restricted to the overall limit of Rs 1.5 lakh prescribed under Section 80CCE of the Act.Section 80CCE specifies the aggregate level of deduction available under sections 80C and 80 CCD(1) of the Income-tax Act. Thus, investment in section 80C basket (EPF, PPF contributions etc.) and section 80CCD (1) (NPS contributions - directly or via employer) in a financial year cannot exceed the specified limit of Rs 1.5 lakh in a financial year.Currently, Section 80CCE allows an individual to deduct up to Rs1.5 lakh from gross total income (before calculating tax payable) if this Rs 1.5 lakh is invested in specified avenues (including NPS). Certain specified expenditures also qualify for deduction under this Rs 1.5 lakh limit of section 80CCE. Examples of specified expenditures include repayment of principal amount of home loan, children school fees etc.Do keep in mind that the maximum amount that can be invested in NPS for claiming deduction under section 80CCD (1) cannot exceed 10% of the basic salary of an individual. Therefore, if the 10% of basic salary is below Rs 1.5 lakh, say Rs 90,000, then to fully utilise the benefit of Rs 1.5 lakh available under sections 80C and 80CCD (1), the difference, i.e., Rs 60,000 in this case, has to be invested in other specified avenues available under section 80C such as Provident Fund, tax-saving fixed deposits etc. Rs50,000 can be deposited in NPS under section 80CCD (1b) in addition to the Rs 90,000 mentioned above. This deduction of Rs 90,000 will be claimed under section 80CCD (1).Additional deduction in NPSTo encourage investment in NPS, Section 80CCD(1B) of the Income-tax Act allows an additional deduction of Rs 50,000 over and above the Rs 1.5 lakh available under Section 80CCE. Thus, where the individual taxpayer has exhausted the limit of Rs 1.5 lakh under Section 80CCE by making other investments eligible for deduction under the said section (apart from NPS), contribution made by him/her (either by himself or through deduction from salary) towards NPS can be utilised to claim additional deduction of Rs 50,000 under Section 80CCD(1B). Certain illustrative scenarios on claim of deduction by an individual are provided below: Amount contributed Deduction under Section 80CCE (max Rs 1.5 lakh) Deduction under Section 80CCD (1B) (max Rs 50,000) Individual taxpayer contributes Rs 2 lakh to NPS through employer (as deduction from salary) Available Available Individual taxpayer contributes Rs 2 lakhs to NPS directly Available Available PF contribution by individual taxpayer is Rs 1.5 lakh and NPS contribution is INR 50,000 (Which taxpayer makes himself or is deducted by the employer from his salary) Available (for PF contribution) Available Individual taxpayer contributes Rs 50,000 to NPS and has no other investment At the option of the individual, deduction can be claimed under either section limited to Rs 50,000 *It is assumed that contribution to NPS by the employee does not exceed 10% of the employees' salary.Employer contributionsTaxation of contributions made by the employer to the NPS account of an employee is governed by Section 17(1)(viii) of the Income-tax Act which states that such contributions are considered as salary income taxable in the hands of the employee. However, a deduction is available under Section 80CCD(2) of the Income-tax Act for the amount contributed by the employer, limited to 10% of basic salary for the financial year (enhanced limit of 14% applicable for Central government employees). The deduction under this section is over and above the deduction available for employee's contribution discussed above and is not subject to the overall limit of Rs 1.5 lakh under Section 80CCE and Section 80CCD (1b). However, the Finance Act, 2020 has amended Section 17(2)(vii) according to which the aggregate of employer's contribution to Provident Fund (PF), NPS and superannuation fund in excess of Rs 7.5 lakh in a financial year is treated as a taxable perquisite for the employee. Further, as per Section 17(2)(viia), any interest, dividend etc. earned on the excess contributions made by the employer over and above Rs 7.5 lakh will also be taxable. The said provision states that the annual accretions attributable to the excess contributions will be computed "in such manner as may be prescribed". However, the guidelines in relation to the computation are still awaited.Certain illustrative scenarios on taxation of employer contributions to NPS are provided below: Amount contributed* Taxable amount under Section 17(1)(viii) Taxable amount under Section 17(2)(vii) Deduction under Section 80CCD (2) Employer contributes Rs 2 lakh to NPS account of employee and no contributions towards PF Rs 2 lakh Nil Rs 2 lakh Employer contributes Rs 2 lakh to NPS account of employee and Rs 2.4 lakh towards PF Rs 2 lakh Nil Rs 2 lakh Employer contributes Rs 4 lakh to NPS account of employee and Rs 4.8 lakh towards PF Rs 4 lakh Rs 1.3 lakh** Rs 4 lakh *It is assumed that contribution to NPS by the employer does not exceed 10% / 14% of the employees' salary.**Interest earned on excess contributions by an employer above Rs 7.5 lakh in financial year. Thus, interest earned on Rs 1.3 lakh will also be taxable under section 17(2)(viia) of the Income-tax Act as mentioned above.(The author is Director - People Advisory Services, EY. The views expressed are personal.)

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