Questions Regards U.S. Federal Tax Consequences of India’s Provident Fund Schemes Under the U.S.-India Income Tax Treaty | SF Tax Counsel (2024)

25Oct 2023 by Anthony Diosdi

By Anthony Diosdi India has a national pension plan that is similar to a social security system. The normal pension age for earnings-related pension benefits from the Employees’ Pension Scheme is 58 years of age with a minimum of ten years of contribution. The pension age for the earnings-related Employees Provident Fund scheme is 55 years of age. Covered individuals belong to the organized sectors and are employed by the government, government enterprises, public and private sector enterprises, which are mandatorily covered by the Employees Provident Fund Organization (“EPFO”). Employees with 20 or more employees are covered by EPFO. The remaining 88 percent of the workforce are mainly self-employed, daily wage workers, farmers, etc and are covered by the EPFO. For this share of the Indian workforce the Public Provident Fund (“PPF”) and Postal Saving Schemes have traditionally been the main long-term instruments.

Employees Provident Fund Schemes (EPT)For employees with basic wages less than or equal to INR 15 000 per month, the employee contributes 12 percent of the monthly salary and the employer contributes 3.67 percent. This combined 15.67 percent accumulates as a lump-sum. For employees with basic wages greater than INR 15 000 per month, the employee contributes 12 percent of the monthly salary while the employer also contributes 12 percent. This combined 24 percent accumulates as a lump sum. There is no annuity and full accumulations are paid after attaining 55 years of age. For comparison with other countries, for replacement rate purposes the pension is shown as a price-indexed annuity based on a mortality table.

Employees’ Pension Scheme (EPS)From September 2014, individuals with a basic wage above 15 000 per month no longer have the option of contributing to the EPS. For participants in the EPS, employers contribute 8.33 percent of the INR 15 000 on a monthly basis and the government contributes a subsidy of 1.16 percent of the salary into the EPS. This accumulation is used to pay various pension benefits on retirement or early termination. The kind of pension a member receives under the pension scheme depends on the age at which they retire and the number of years of eligible service.

Monthly pension = (pension salary x pension service)The pension salary is calculated on the average monthly pay for the contribution period of the last 60 months preceding the date of termination of membership.

The maximum possible replacement rate is roughly 50 percent.

The EPS can be claimed from age 50 with ten years of contributions and the benefits are reduced by 3 percent per year for early retirement. If a member leaves his or her job before rendering at least ten years of service, he or she is entitled to a withdrawal benefit. The amount he or she can withdraw is a proportion of his or her monthly salary at the date of exit from employment. This proportion depends on the number of years of eligible services he or she has rendered. In regards to the EPF, there are multiple scenarios, which allow for early access to benefits. Partial withdrawals related to marriage, housing, financing life insurance, and illness of a family member are permitted.

U.S. Tax Consequences of India’s Provident Fund Schemes

The characterization of the Indian Employee Provident Fund Account is important for U.S. income tax purposes. Under Article 20, Paragraph 2, of the U.S.-Republic of India Income Tax Treaty, “social security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first mentioned State.” In other words, the country of source has exclusive taxing rights to social security income.
This means if an India Employee Provident Fund Account can be classified as social security, India would have exclusive taxing rights to the income and for federal income tax purposes, the U.S. would not have the ability to tax Provident Fund Scheme.

Anyone taking a tax treaty position must consider an article known as a “saving clause.” A saving clause preserves or “saves” the right of each country party to a tax treaty to tax its own residents as if no treaty existed. This typically means that a U.S. citizen or resident attempting to take advantage of a treaty that the U.S. has with a foreign country will be taxed as if the treaty did not exist. Article 20 of U.S.-India income tax treaty contains a saving clause. However, Article 20, Paragraph 2 specifically excludes social security income from the saving clause. As a result, the saving clause prevents U.S. citizens and residents from being taxed from social security received from India. Consequently, if an Employee Provident Fund Account can be classified as Social Security, an India Provident Fund Schedule will escape U.S. taxation.

Anyone wishing to take a position that a Provident Fund Scheme is not subject to U.S. tax under the U.S.-India tax treaty must timely claim a treaty position. Anyone considering taking such a treaty position also must understand that this area is somewhat unsettled. Thus, a U.S. beneficiary of an India social security or public pension plan should consult with a qualified international tax attorney.

ConclusionOften the terms of a U.S. tax treaty modify the tax results that one would otherwise obtain under the Internal Revenue Code. Correctly taking a treaty position can result in substantial tax savings. On the other hand, taking an incorrect treaty position can result in the assessment of significant penalties and interest by the IRS. If you are considering taking a treaty position regarding a United States or India based retirement account, you should consult with an experienced international tax attorney to assist you. We have advised a substantial number of clients regarding taking income tax treaty positions in connection with U.S. based and foreign retirement plans..

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on providing tax planning domestic and international tax planning for multinational companies, closely held businesses, and individuals. In addition to providing tax planning advice, Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.