Taxation of retirement benefits in Pakistan is governed by the Income Tax Ordinance, 2001, which is administered by the Federal Board of Revenue (FBR). Retirement benefits include any payments received by an employee upon retirement, including gratuity, pension, commutation of pension, and other similar payments. In this article, we will discuss the basic concepts, definitions, and examples of taxation of retirement benefits in Pakistan.
Basic Concepts:
Before we dive into the taxation of retirement benefits, let’s understand some basic concepts that are relevant to this topic:
Retirement:
Retirement is the termination of an employee’s service after reaching the age of superannuation or after completing a specified period of service.
Gratuity:
Gratuity is a lump-sum payment made to an employee by the employer as a token of appreciation for their services. Gratuity is usually paid at the time of retirement or resignation.
Pension:
Pension is a regular payment made to an employee by the employer after retirement. The pension amount is usually calculated based on the employee’s length of service and the average salary earned during the last few years of service.
Commutation of Pension:
Commutation of pension is the conversion of a portion of the pension into a lump-sum payment at the time of retirement.
Definitions:
Now let’s understand some key definitions that are relevant to the taxation of retirement benefits in Pakistan:
Taxable Retirement Benefits:
Taxable retirement benefits are the payments received by an employee upon retirement that are subject to income tax. These include gratuity, pension, commutation of pension, and any other payments made to the employee upon retirement.
Tax-exempt Retirement Benefits:
Tax-exempt retirement benefits are the payments received by an employee upon retirement that are exempt from income tax. These include any payments received from a recognized provident fund, gratuity payments up to a certain limit, and any other payments specified as tax-exempt by the FBR.
Taxable Year:
The taxable year is the period for which an employee’s income is assessed for tax purposes. In Pakistan, the taxable year is from July 1st to June 30th of the following year.
Taxpayer:
A taxpayer is a person who is liable to pay income tax. In the case of retirement benefits, the taxpayer is the retired employee who receives the payments.
Examples:
Let’s now look at some examples to understand how the taxation of retirement benefits works in Pakistan:
Example 1:
Mr. Ali retired after completing 25 years of service. He received a gratuity payment of PKR 2,000,000 from his employer and a pension of PKR 100,000 per month. What is his tax liability for the year?
Solution: Mr. Ali’s gratuity payment of PKR 2,000,000 would be subject to income tax. However, the first PKR 2,000,000 of gratuity received by an employee is tax-exempt in Pakistan. Therefore, Mr. Ali’s entire gratuity payment would be tax-exempt. His monthly pension of PKR 100,000 would be subject to income tax. His taxable income for the year would be PKR 1,200,000 (PKR 100,000 x 12). His income tax liability for the year would be calculated based on this taxable income.
Example 2:
Ms. Fatima retired after completing 20 years of service. She received a gratuity payment of PKR 1,500,000 from her employer and a pension of PKR 80,000 per month. She also commuted PKR 400,000 from her pension. What is her tax liability for the year?
Solution: Ms. Fatima’s gratuity payment of PKR 1,500,000 would be subject to income tax. However, the first PKR 2,000,000 of gratuity received by an employee is tax-exempt in Pakistan. Therefore, PKR 1,500,000 of her gratuity payment would be tax-exempt, and the remaining PKR 500,000 would be subject to income tax. Her monthly pension of PKR 80,000 would be subject to income tax. However, she also commuted PKR 400,000 from her pension, which would be tax-exempt. Her taxable income for the year would be PKR 720,000 (PKR 80,000 x 12). Her income tax liability for the year would be calculated based on this taxable income.
Example 3:
Mr. Hassan retired after completing 30 years of service. He received a gratuity payment of PKR 3,500,000 from his employer and a monthly pension of PKR 150,000. What is his tax liability for the year?
Solution: Mr. Hassan’s gratuity payment of PKR 3,500,000 would be subject to income tax. However, the first PKR 2,000,000 of gratuity received by an employee is tax-exempt in Pakistan. Therefore, PKR 2,000,000 of his gratuity payment would be tax-exempt, and the remaining PKR 1,500,000 would be subject to income tax. His monthly pension of PKR 150,000 would be subject to income tax. His taxable income for the year would be PKR 3,300,000 (PKR 150,000 x 12 + PKR 1,500,000). His income tax liability for the year would be calculated based on this taxable income.
Conclusion:
In conclusion, the taxation of retirement benefits in Pakistan is a complex process that involves various concepts and definitions. It is important for retired employees to understand their tax liabilities and take advantage of tax-exempt retirement benefits to reduce their taxable income. Employers are responsible for deducting income tax at the time of payment and submitting it to the FBR on behalf of their retired employees.
