Exempt-Exempt Tax

The Exempt–Exempt–Tax (EET) system refers to a method of taxation applied to savings and investment schemes, particularly retirement or long-term savings instruments. Under this system, contributions and returns (interest or dividends) are exempt from tax during the investment and accumulation phases, but the withdrawals (maturity amount) are taxable at the time of redemption.
The EET model is one of the three main taxation structures applied to savings worldwide — alongside Exempt–Exempt–Exempt (EEE) and Exempt–Tax–Exempt (ETE) systems.

Meaning of “Exempt–Exempt–Tax”

The three terms in the EET model correspond to different stages in the life cycle of an investment:

Hence, while savings and growth are tax-free during investment and accumulation, the final payout is taxed, often at the investor’s marginal income tax rate.

Example of the EET System

Suppose an individual invests ₹1,00,000 annually in a retirement fund:

• Contribution Stage: The ₹1,00,000 invested is deducted from taxable income under Section 80C → Exempt.
• Accumulation Stage: Interest or returns accrued over years are not taxed → Exempt.
• Withdrawal Stage: When the total amount (say ₹20,00,000 after several years) is withdrawn at retirement, it is treated as taxable income → Taxed.

EET vs. EEE System

The EEE system is more beneficial to investors, as withdrawals are tax-free, while the EET system shifts taxation to the time of payout, allowing governments to tax income when individuals are likely to be in lower tax brackets (post-retirement).

EET in the Indian Context

India currently follows a mixed system, applying both EEE and EET tax regimes to different instruments.
Examples of EET Schemes in India:

• National Pension System (NPS):
  • Contributions eligible for deduction under Section 80CCD(1) and 80CCD(1B) → Exempt.
  • Accumulated returns not taxed until withdrawal → Exempt.
  • Withdrawal partially taxable (60% of corpus exempt; 40% taxable as per Finance Act, 2020) → Partially Taxed.
• New Pension Schemes of insurance companies and some superannuation funds also follow the EET model.

Examples of EEE Schemes in India:

• Public Provident Fund (PPF)
• Employees’ Provident Fund (EPF)
• Sukanya Samriddhi Yojana (SSY)
• Life Insurance Maturity Proceeds (subject to conditions under Section 10(10D))

Rationale for Adopting the EET System

1. Deferred Tax Revenue:
   • Allows the government to collect tax later, reducing immediate fiscal burden.
2. Encouragement to Save:
   • By providing upfront tax benefits, it motivates individuals to invest for the long term.
3. Fairness:
   • Ensures that taxation occurs when the benefit is realised (at withdrawal).
4. Alignment with Global Practice:
   • Many countries, including the U.S. (401(k) plans) and U.K. (pension schemes), use EET-type taxation for retirement savings.

Advantages of EET

• Encourages long-term savings due to upfront tax relief.
• Tax deferral benefits: Investors can earn tax-free compounding until withdrawal.
• Simplified monitoring: Easier for authorities to track taxation at the payout stage.
• Potential for lower tax rates upon withdrawal, as retirees may fall under lower income brackets.

Disadvantages of EET

• Tax burden at retirement: Reduces net savings for retirees when they withdraw funds.
• Uncertainty in future tax rates: Changes in tax laws may affect the tax liability on withdrawals.
• Complex calculations: Taxation at withdrawal requires assessment of total income at that time.
• Psychological disincentive: Individuals may prefer fully tax-free options (EEE) for security and clarity.

Global Perspective

Many countries follow the EET principle for retirement and pension savings, allowing tax-deferred growth:

These systems balance incentives for saving with deferred taxation, aligning with individuals’ income life cycle.

Relevance for India’s Future Tax Policy

• The Government of India has discussed shifting all long-term savings schemes to the EET model to ensure a uniform taxation framework and long-term revenue stability.
• However, the proposal faces opposition due to its potential impact on small savers and middle-income groups who currently benefit from EEE schemes.