Understanding Gratuity in Pakistan: Tax Implications and Exemptions

Gratuity, a one-time payment received by an employee upon retirement, resignation, or death, is a significant financial benefit. However, when it comes to taxes in Pakistan, gratuity treatment can be nuanced. This article explores how gratuity is classified as part of your salary income while also outlining the specific scenarios under which it enjoys tax exemption.

Gratuity as Salary Income:

The Income Tax Ordinance, 2001, defines “salary” as any amount received by an employee from employment, including:

• Pay, wages, or other remuneration
• Leave pay
• Payment in lieu of leave
• Overtime payment
• Bonus
• Commission
• Fees
• Gratuity
• Work condition supplements

Therefore, gratuity is considered part of your overall taxable salary income in Pakistan.

Tax Exemptions for Gratuity:

While gratuity is generally included in your salary for tax purposes, the Income Tax Ordinance provides specific exemptions under certain conditions. These exemptions are detailed in the Second Schedule of the Ordinance, offering tax relief on a portion of the gratuity received.

Exemption Categories:

There are four primary categories for gratuity tax exemption:

1. Government Employees and Certain Entities: Employees of the government, local authorities, statutory bodies, or corporations established by law are exempt from tax on the entire gratuity amount received as per their service rules. This ensures a tax-free benefit upon retirement or other qualifying events.

2. Approved Gratuity Funds: If your gratuity comes from a gratuity fund approved by the Commissioner under specific rules (Part III of the Sixth Schedule), the entire amount is exempt from tax. These funds often exist in larger organizations and follow strict regulations to ensure fair distribution of gratuity benefits.

3. Employer-Sponsored Gratuity Schemes: For private-sector employees, gratuity received under a scheme applicable to all employees and approved by the Federal Board of Revenue (FBR) for tax purposes can be partially exempt. The current exemption limit is PKR 300,000. This incentivizes employers to offer standardized gratuity schemes with tax benefits for their employees.

4. Other Employees: If you don’t fall under categories (i), (ii), or (iii) above, you can still claim a partial exemption on your gratuity. The exempt amount is the lesser of 50% of the gratuity received or PKR 75,000. This provides some tax relief even for employees without employer-sponsored schemes or government employment.

Important Exclusions:

It’s crucial to remember that these exemptions come with specific exclusions:

• Gratuity Received Outside Pakistan: Any gratuity payment received outside Pakistan is not eligible for tax exemption under the Income Tax Ordinance.
• Company Directors: If you’re a company director who isn’t a regular employee, the gratuity exemption doesn’t apply.
• Non-Resident Individuals: Gratuity received by a non-resident taxpayer in Pakistan isn’t eligible for exemption.
• Multiple Gratuities: The exemption only applies to the first gratuity received from an employer. If you’ve already received a gratuity from the same or another employer, you won’t be eligible for this exemption on subsequent payments.

Example:

Suppose Sarah, a government employee in Pakistan, receives a gratuity of PKR 1,000,000 upon retirement. As per her service rules, this amount falls under category (i) and is entirely exempt from tax. Sarah won’t have to pay any tax on this gratuity income.