Dear Mr. Saeed,
I would like to take this opportunity to inform you that the general rules relating to taxation of gratuity payments are summarized as under:
(a) Gratuity received by employee of Government Institutions is fully exempt from tax;
(b) Gratuity received from gratuity funds approved by Commissioner of Income Tax is exempt from tax in entirety;
(c) Payment received under a gratuity scheme approved by Federal Board of Revenue (FBR) is exempt from tax to the extent of two hundred thousand rupees (Rs. 200,000);
(d) Gratuity payments not covered under (a) to (c) above are exempt from tax to the extent of fifty percent (50%) of the amount received subject to a maximum of seventy five thousand rupees (Rs.75,000)
These exemptions will however not apply to payments received:
· Outside Pakistan;
· by a director of a Company who is not a regular employee of the company;
· by an employee who is not a resident;
· by an employee who has previously received gratuity from the same or any other employer.
Where the amount of gratuity is wholly or partially taxable the employee can elect for the amount to be taxe3d at the rate applicable for tax year or at the rate computed in accordance with the following formula:
A / B X 100
Where – A is the total tax paid or payable by the employee for three preceding tax years; and B is the employee's total taxable income for the three preceding tax years.
This is simplified by way of the following example:
An employee of a private limited company received Rs.3,500,000 as taxable gratuity from his employer during tax year 2008. His taxable income and tax liability for the preceding three years is as under:
| Tax Year | Taxable Income (Pak Rupees) | Tax Liability (Pak Rupees) |
| 2005 | 700,000 | 120,500 |
| 2006 | 900,000 | 189,000 |
| 2007 | 1,100,000 | 257,500 |
| TOTAL | 2,700,000 | 567,000 |
The employee has decided to pay tax on the basis of average tax rate computed with reference to the preceding three tax years.
The tax rate to be applied to the gratuity payment of Rs.3,500,000 will be computed as under:
567,000 / 2,700,000 X 100 = 21%
Accordingly, the gratuity payment of Rs.3,500,000 will be taxed at 21% irrespective of a higher tax rate applicable for Tax Year 2008.
According to Section 12(8) of Income Tax Ordinance, 2001, where an employee selects to be taxed at a rate calculated with reference to data relating to the preceding three years, he/she is required to inform the Commissioner in writing of such mode of taxation by the date on which tax returns and employer certificates are due for filing, that is 30th September following the end of the tax year. In case the employee does not inform the Commissioner of selection made, the amount of gratuity will be taxed at the rate applicable for the tax year in which the amount is received.
I hope this would suffice your needs and I would be pleased to discuss any point you may require to clarify.
Regards
S. Sajjad H.Abidi
Cell: +92 300 8417948
Cell: +92 333 4352740
