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How are funds withdrawn from NPS taxed?

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How is tax calculated on withdrawal of funds from the National Pension System (NPS) Tier 2 account ? Should I treat it as capital gain and calculate taxes on the gains, considering it as an equity mutual fund (since my major contribution is in equities)? Or, should I file the tax returns, considering it as a part of the income? Also, do I have to pay taxes only on the interest or the entire sum withdrawn? The tax on the invested money is already considered in the previous investment year.

—Name withheld on request

There are no specific provisions in the Income-tax Act, 1961, governing the taxation of withdrawal from NPS Tier II account. Thus, the taxability of withdrawals from this account would need to be analyzed based on general principles of taxation. Divergent views exist in this regard, in the absence of specific provisions.

It is understood that investment in the NPS account is in the form of units, whose net asset value (NAV) varies over a period of time. Hence, there is a view that at the time of withdrawal, these units are redeemed and hence the gains/ loss therefrom may be taxed under the head ‘capital gains’.

It may however be noted that the units held in the NPS account cannot be considered as the equity shares of a company or the units of an equity-oriented fund and hence a holding period of 36 months may be applied to determine its tax rate. The tax rate will depend on whether the units ultimately classify as short term or long term.

There is also an alternate school of thought that says the withdrawals may be offered to tax as ordinary income under the head “Income from Other Sources”, to the extent off the differential between the redemption value and amount invested (i.e., only the accretions) though there is no provisions for the same.

Parizad Sirwalla is partner and head, global mobility services, tax, KPMG in India.

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