Taxation Management

NK FACT

HEADS OF INCOME ::: SALARY INCOME ALLAMA IQBAL OPEN UNIVERSITY NK FACT COLLEGE

Students are instructed to also study this topic from approved study text books.

TARIQ A. MIR ACA APA

TARIQ MIR

Taxation Management

NK FACT

INTRODUCTION A person may earn and receive income from different sources during a tax year. For the purpose of determining the taxable income and tax liability these heads of income are classified as: i. ii. iii. iv. v. Salary Income from house property Income from business or profession Capital gains Income from other sources

The presence of the fifth dead income from other sources ensures that any income which cannot be included in any of the first four heads must be taxed under this general head. FEATURES OF SALARY INCOME: i. ii. iii. iv. v. Salaried individuals are individuals whose salary income exceeds 50% of the taxable income for the tax year. Non-salaried individuals: are individuals other than salaried individuals. Employee means an individual engaged in employment. Employer means any person who engages and remunerated an employee. Employment means a. A directorship or any other office involved in management of a company b. A position entitling the holder to a fixed or ascertainable remuneration c. The holding or acting in a public office Salary must be received from an employee from his present or past employer. It is necessary that relationship of employer and employee should exist. If such a relationship does not exist the amount cannot be charged under this head. Salary must be paid by the government, local authority, company, public body, association or private employer in Pakistan. Income received from a foreign government is not taxed under this section. Pension income is included in salary. Salary earned is taxable whether received or not. No deduction shall be allowed for any expenditure incurred by an employee in deriving amounts chargeable to tax under the head Salary.

vi. vii. viii. ix. x.

SALARY (section 12)

Salary is reward for services performed. For the purpose of ITO 2001 Salary means any amount received by an employee from any employment. It includes any i. pay, ii. wages iii. leave pay /payment in lieu of leave, iv. overtime, v. bonus, vi. commission, vii. fees, viii. gratuity ix. work condition supplements (such as for unpleasant or dangerous working conditions) x. any perquisite, whether convertible to money or not; xi. any allowance provided by an employer to an employee including a cost of living, subsistence, rent, utilities, education, entertainment or travel allowance, xii. the amount of any expenditure paid or reimbursed by the employer xiii. the amount of any profits in lieu of, or in addition to, salary or wages, xiv. any pension or annuity, or any supplement to a pension or annuity Provided that any bonus paid or payable to corporate employees receiving salary income of one million rupees or more (excluding bonus) in tax year 2010, shall be chargeable to tax at the rate of 30%. This charge is for tax year 2010 only and is called IDP tax.

TARIQ MIR

Taxation Management

NK FACT

Tax Free Salary: Where an employee agrees to pay the tax liability of the employee. Then the amount so paid will be treated as an additional benefit to the employee and will be included in his salary income. Tax on Amounts Received on Termination of Employment: any amount received on termination of employment including compensation for redundancy or loss of employment, golden handshakes etc may at the option of the employee be taxed in any of the following ways. i. ii. It may be included in the taxable income of the year in which it is received It may be taxed as a separate block at the rate calculated using the following formula A/B x 100 A = the tax paid or payable by the employee on his total taxable income for the three preceding tax years B = employees total taxable income for the three preceding tax years. Tax on Salary Received in Arrears: any amount received by an employee in arrears may at the option of the employee be taxed at such rates that would have been applicable if the salary has been paid in the tax year in which services were rendered by him. This option may be exercised if the following conditions are fulfilled. i. The taxpayer has received salary in arrears ii. The receipt has been included in the total income of the year in which it is received iii. The inclusion has resulted in the application of a higher rate of tax. The taxpayer will have to apply to the commissioner in writing to exercise this option. PERQUISITES, ALLOWANCES AND BENEFITS: Section 13 of the ITO 2001 and rules 3 to 7 of the Income Tax Rules 2002 discuss the provisions regarding the valuation of different perquisites, allowances and other benefits. Under the ITO 2001 perquisites include: i. ii. iii. iv. v. vi. Value of rent-free accommodation The value of any concession in the rent of any accommodation Any payment by the employer for the benefit of the employee, his spouse or dependent children, e.g. payment of life insurance or payment towards a contact of annuity The value of any benefit provided free of cost or provided at a concessional rate Any sum paid by an employer in respect of any obligation of the employee Facility of motor vehicle provided to the employee wholly or partly for private use of the employee

Profit in Lieu Of or In Addition To Salary includes any amount received as consideration: i. ii. iii. iv. v. to enter into an employment relationship; for an employees agreement to any conditions of employment or any changes thereto. on termination of employment, including any compensation for redundancy or loss of employment and golden handshake payments; from a provident or other fund, to the extent to which the amount is not a repayment of contributions made by the employee; and for an employees agreement to a restrictive covenant in respect of any past, present or prospective employment.

Salary for Determining the Value of Perquisites, Allowances and Benefits: For the purpose of determining the value of perquisites, allowances and benefits salary includes: i. Basic salary, overseas allowance, dearness allowance, cost of living allowance, bonus and commission. ii. Does not include employers contribution to a recognized provident fund, superannuation fund or gratuity fund. iii. Any other amount paid by the employers if it enters into the computation of pension and retirement benefits. Valuation of Accommodation: The value of accommodation provided by an employer to the employee shall be taken equal to the amount that would have been paid by the employer in case such accommodation was not provided. Provided that the value taken for this purpose shall not be less than 45% percent of the MTS or basic salary i.e. the higher of the following two amounts will be included in salary i. Fair market rent of the accommodation; or ii. 45% of MTS or basic salary House Rent Allowance @ 30%: where House Rent Allowance is admissible @ thirty per cent, the value taken for accommodation shall be higher of:
TARIQ MIR 3

Taxation Management

NK FACT

i. Fair market rent of the accommodation; or ii. 30% of MTS or basic salary Valuation of Conveyance: Where a motor vehicle is provided to an employee the amount chargeable to tax to the employee under the head Salary for that year shall be computed in accordance with the following table. SR # 1 TYPE OF MOTOR VEHICLE Partly for personal and partly for official use AMOUNT TO BE INCLUDED IN SALARY 5% of the cost to the employer for acquiring the motor vehicle; or, the fair market value of the motor vehicle at the commencement of the lease. 10% of the cost to the employer for acquiring the motor vehicle; or, the fair market value of the motor vehicle at the commencement of the lease.

Personal use only

Conveyance Allowance: Where the employee is provided a conveyance allowance, the whole amount will be included in taxable income. Medical Charges: free medical treatment or hospitalization or the reimbursement of medical charges or hospital charges provided by an employer will be exempt from tax provided: i. ii. It is in accordance with the terms of employment: that National Tax Number of the hospital or clinic is given and the employer also certifies and attests the medical or hospital bills

Any medical allowance received by an employee not exceeding ten per cent of his basic salary is also exempt if free medical treatment or hospitalization or reimbursement of medical or hospitalization charges is not provided. Entertainment: following rules apply to entertainment expenses received by an employee: i. ii. iii. iv. actual entertainment expenses incurred by an employee on behalf of the employer and then reimbursed to him are not taxable free tea, coffee etc. provided to the employee at the office premises during the course of his work are not taxable free or subsidized food provided to an employee of a hotel or restaurant are not taxable in all other cases, the amount of entertainment allowance received by the employee will be added to his total income (Taxable) means included in the total income.

Loan to an Employee: If on or after July 01, 2002 (tax year 2003) a loan is given by an employer to an employee and either no interest / profit on loan is payable by the employee or the rate of interest /profit on loan is less than the benchmark rate, than one of the following two amounts will be included in salary income: i. ii. the amount of interest / profit on loan computed at the benchmark rate, where no interest / profit on loan is payable by the employee, or The amount computed at the benchmark rate less the actual amount of interest / profit paid by the employee, if a lower rate is applicable on the loan.

Benchmark rate for the tax year 2003 was 5%. For each following tax year the benchmark will be increased by 1%. Thereby the benchmark rate for tax year October 2012 was 10%. Special Allowance: any special allowance received by an employee to meet expenses incurred in the performance of official duties is completely exempt from tax. Domestic Servants: total salary paid by an employer for the services of a housekeeper, driver, gardener or other domestic assistant provided to an employee shall be included in the taxable income of the employee. (taxable) Utilities to Employees: Where utilities (Electricity, Gas, Water and Telephone) are provided by an employer to an employee, the fair market value of the utilities, as reduced by any payment made by the employee shall be included in salary income. Any obligation of the employee: Where an obligation of an employee to pay or repay an amount to another person is paid by the employer, this amount will be included in salary income. Any Other Perquisite: the amount calculated as below shall be included in taxable income of the employee: Fair market value of the perquisite XX
TARIQ MIR 4

Taxation Management

NK FACT

Less: payment made by the employee XX Amount to be included in salary XX Taxation of Provident Funds: A provident fund is a fund created by an employer for the future welfare and benefits of his employees. A certain percentage of the employees salary is deducted and deposited in the fund; generally the employer also contributes an equal amount. Contributions of both the employer and the employee are deposited to the provident fund. The amount in the fund is invested in securities and the income from these securities is proportionally credited to the employees accounts. Upon retirement, the total amount standing to the credit of the employee is paid to him. The final payment represents the following amounts: i. ii. iii. the employees contributions the employers contributions the interest / profit on both contributions.

Under the ITO 2001 provident funds are categorized in following three categories: i. ii. iii. Government Provident Funds: (Govt Organizations: WAPDA, Pakistan Armed Forces. etc) Recognized Provident Funds: (Fund maintained by a private organization but approved by CIT) Unrecognized Provident Funds: (Fund maintained by a private organization and NOT approved by CIT)

Taxability of the contributions, credit of interest and receipt of accumulated balance at the time of termination are tabulated below: Event Employees contribution Employers Contribution Interest Credited during the year Payment of Accumulated balance Government Provident Fund No Treatment Exempt Exempt Recognized Provident Fund No Treatment Exempt lesser of 1/10th of Salary or PKR 100,000. Any Excess amount is taxable Exempt up to higher of 1/3rd of Salary or the amount of interest calculated at the rate of 16% Exempt Unrecognized Provident Fund No Treatment No Treatment at this stage No Treatment at this stage

Exempt

Totally exempt if the fund is formed under the Provident Fund Act 1925. Otherwise, only the employers contribution and interest thereon is taxable in the year of receipt.

Note: for the purpose of provident funds, salary only includes dearness allowance. All other allowances and perquisites are excluded. Employee Share Schemes: Employee Share Scheme means an agreement under which the company issues shares to the following persons: i. ii. iii. an employee of the company an employee of an associated company the trustees of a trust (the trustees may transfer the shares to the employee of the company or the employee of an associated company)

These shares represent a benefit to the employee and are taxed as follows: i. the value of any right or option to acquire shares is not taxable ii. the right or option to acquire shares may be given to employees without receiving any amount for it or the company may receive an amount (in addition to the consideration received against shares) iii. the amount to be included in salary income will be calculated as below: Fair Market Value of shares at the date of issue XX Less Consideration given by the employee for shares (XX) Less Amount paid for the right or option (XX) Amount chargeable to tax under the head salary XX

TARIQ MIR

Taxation Management

NK FACT

ALLOWABLE DEDUCTIONS: once total income has been calculated, the following payments (if any) will be deducted from total income to arrive at taxable income. i. ii. iii. iv. v. Zakat paid or deducted under Zakat and Usher Ordinance Contribution to Workers Welfare Fund Contribution to Workers Participation Fund Donations to approved persons subject to the following limits (clause 61, second schedule) a. 30% of taxable income for individuals and AoPs b. 20% of taxable income for companies Donations to Presidents Relief Fund for Earthquake Victims 2005.

FULL TIME TEACHER OR RESEARCHER: The tax payable by a full time teacher or a researcher, employed in a nonprofit education or research institution duly recognized by Higher Education Commission, a Board of Education or a University recognized by the Higher Education Commission, including government training and research institution, shall be reduced by an amount equal to 75% of tax payable on his income from salary. TAX REBATE FOR SENIOR CITIZENS: Where the taxable income of a taxpayer aged 60 years or more on the first day of that tax year does not exceed Rs. 750,000, his tax liability shall be reduced by 50%. AVERAGE RELIEF: Tax concessions are allowed for the following expenditures and investments. i. Donations for charitable purposes ii. Investments in shares iii. Contributions to approved Pension fund iv. Profit on debt Donations for Charitable Purposes: A person shall be entitled to a tax credit in respect of any amount paid, or any property given by the person in the tax year as a donation subject to the following conditions: i. ii. iii. iv. The donations were made during the tax year The taxpayer possesses evidence in respect of the donations made The donations may be made in cash or in kind. Cash donations should be made through a cross cheque. Donations should be to the following institutions a. board of education or any university in Pakistan established under a Federal or a Provincial law; b. educational institution, hospital or relief fund established or run in Pakistan by Federal/Provincial/Local Govt; or c. non-profit organization. The tax credit will be restricted to the lesser of the following amounts a. The actual amount of the donations; or b. 30% of the taxable income for the year, if the person is an individual or AOP c. 20% of the taxable income for the year, if the person is a company

v.

The amount of tax credit allowed shall be computed according to the following formula: (Gross Tax / Taxable Income) x Donations admissible for average relief If a property is donated the fair market value of any property at the time it is given shall be taken to be the amount of donation. A cash amount paid by a person as a donation shall only be allowable if it was paid by a crossed cheque drawn on a bank. Tax credit is calculated at the average rate of tax. A straight deduction from total income shall not be made, unless the donation is made to such institutions are specified in Clause 61 of Part I of Second Schedule. Investment in Shares: A tax credit at the average rate of tax shall be allowed to a person (other than a company) if the following conditions are fulfilled. i. Taxpayer has made investments in the purchase of a. new shares offered by a public listed company b. shares sold by the Privatization Commission of Pakistan ii. in case of new shares, taxpayer should be the original allottee iii. tax credit is allowed for an investment, which is lesser of the following amounts a. total cost of acquiring the shares b. ten per cent of the persons taxable income
TARIQ MIR 6

Taxation Management

NK FACT

c.

three hundred thousand rupees.

Where a person has been allowed a tax credit in respect of the purchase of a share; and the person disposes of the share within twelve months of the date of acquisition, than his tax liability for the tax year in which the shares were disposed of shall be increased by the amount of the credit allowed. Contribution to an Approved Pension Fund: A tax credit at the average rate of tax shall be allowed to an eligible person in respect of any contribution or premium paid to an approved pension fund, subject to the following conditions: i. ii. iii. iv. the person should possess a valid National Tax Number the pension fund should be approved under the Voluntary Pension System Rules 2005 the person is deriving income chargeable to tax under the head Salary or Income from Business tax credit allowed will be the lessor of the following amounts a. total contribution or premium paid b. 20% of the eligible persons taxable income for the tax year c. Rupees 500,000/If the person joins this scheme at the age of 41 years or more the limit of 20% mentioned above will be enhanced by 2% for each year above 40. However, contribution in such cases should not exceed 50% of taxable income.

v.

Mark up on Housing Finance Scheme: A tax credit at the average rate of tax shall be allowed to a person if he has paid any amount of interest (markup or share in rental income and share towards the appreciation in the value of the house, excluding return of capital) on loans borrowed for acquisition of houses. Tax credit shall be allowed if the following conditions are fulfilled. i. Loan is obtained on or after July 01, 2001 ii. The loan has been advanced or sanctioned by a. A scheduled bank b. A non-banking finance company regulated by SECP c. The government, local government d. Statutory body e. A public listed company iii. The loan is utilized for the construction or acquisition of a house iv. The tax credit shall be allowed for an amount which is lesser of the following a. Total amount of profit on debt paid b. 50% of the taxable income for the year c. PKR 750,000 v. The amount of interest has not been deducted from income from property

TARIQ MIR

Taxation Management

NK FACT

NAME : MR AY BEE CEE NATIONAL TAX NUMBER: XXX TAX YEAR : 2010 TAX YEAR ENDED : 30 JUNE 2010 PERSONAL STATUS: INDIVIDUAL RESIDENTIAL STATUS : RESIDENT COMPUTATION OF TAXABLE SALARY INCOME

PKR
Basic salary Dearness allowance Cost of living allowance Overseas allowances Bonus (N-9) Commissions Leave encashment (N-1) Overtime Gas Water Electricity Telephone Compensatory allowance (exempt if up to 75% of gross xxx salary) xxx less: Any amount above 75% of gross salary Tax on salary - paid by employer (in case of tax free salary) Amount received on termination of employment (N-2) Salary received in arrears (N-3) Services of domestic servants( e.g. drivers, maids, etc) Interest free loan (N-4) Waiver of an amount payable by employee Employee obligation paid by employer Transfer of property OR provision of services to employee xxx Fair value of property or services xxx less: Any amount paid by employee House Rent allowance Rent Free accommodation (higher of FMR or 45% (or 30%) of MTS / Basic salary) Conveyance allowance Value of conveyance (N-5) Leave fare allowance (N-6) xxx Entertainment allowance xxx less: amount related to official work Employer's contribution to a provident fund Government Provident fund - Totally exempt Unrecognized Provident fund - No Treatment xxx Recognized Provident fund less: Exempt lesser of 10% of salary OR Rs.100,000 xxx
TARIQ MIR 8

PKR xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx xxx xxx xxx xxx xxx xxx

-

xxx

Taxation Management

NK FACT

(N-7)
Interest on provident fund Government Provident fund - Totally exempt Unrecognized Provident fund - No Treatment Recognized Provident fund less: higher of 1/3rd of salary OR amount calculated @ 16% Receipt of accumulated balance of provident fund Government Provident fund - Totally exempt Unrecognized Provident fund - No Treatment Recognized Provident fund (N-8) Profit in lieu of OR in addition to Salary Gratuity Or Commutation of pension Received from Government, local govt etc - totally exempt Received from approved superannuation fund - totally exempt Received from gratuity scheme approved by FBR Less exempt up to Rs. 200,000 Any other case less: lower of Rs. 75000 or 50% of amount received Pension- Only one with higher amount is exempt Any other benefits, allowances, etc

xxx
-

xxx xxx xxx

-

xxx xxx

xxx 20000 0 xxx xxx

xxx xxx xxx xxx

Total taxable salary income NOTES

N-1 N-2 N-3 N-4 EXEMPT FOR GOVT. EMPLOYEES.

XXX

EITHER CHARGE IT TO SALARY INCOME IN THE RECEIVING TAX YEAR OR CHARGE @ ANY AVERAGE TAX RATE OF IMMEDIATE 3 PREVIOUS TAX YEARS. AT THE DISCRETION OF TAX PAYER HE/SHE CAN EITHER PAY TAX ON RECEIPT BASIS OR IN THE TAX YEAR WHEN THE SERVICES WERE RENDERED. AN AMOUNT EQUAL TO BENCHMARK RATE SHALL BE TREATED AS INCOME & IF INTEREST CHARGED BY EMPLOYER IS LESS THAN BENCHMARK, THEN THE DIFFERENCE IS TO TAKEN AS INCOME. THE VALUE OF CONVEYANCE SHALL BE DETERMINED AS PER Rule-5 IN SALARY INCOME. THE WHOLE AMOUNT PAID BY EMPLOYER ON LFA IS TO BE INCLUDED IN SALARY INCOME. "SALARY" FOR PROVIDENT PURPOSES MEANS THE ACTUAL DRAWN SALARY + DEARNESS ALLOWANCE. ONLY EMPLOYER'S CONTRIBUTION & INTEREST ON IT IS TAXABLE. WHEN SALARY OF CORPORATE EMPLOYEE FOR THE TAX YEAR 2010 ( EXCLUSIVE OF BONUSES) IS Rs. 1 MILLION OR MORE, IT IS TO TREATED SEPERATELY & IDP TAX @ 30% OF BONUS IS APPLIED.

N-5 N-6 N-7 N-8 N-9

TARIQ MIR

Taxation Management

NK FACT

Example S-1

Mr. Zuhair Ahmed is an employee. His info for the tax year 2010. Basic salary per annum Bonus Cost of living allowance Dearness allowance Rent free unfurnished accommodation - annual value Company maintained car for personal & official use, cost of vehicle is Utility allowance Leave encashment LFA for every year Hotel bills paid by the company relating to a pleasure trip Employer's contribution towards provident fund Zakat paid under zakat & usher ordinance Tax deducted by company from salary

PKR
240,000 36,000 36,000 12,000 132,000 880,000 48,000 21,600 21,600 26,400 20,000 5,000 25,000

Compute the total income, taxable income & the Tax liability. SOLUTION
Computation of Taxable Income of Mr. Ahmed.
Basic salary Bonus Cost of living allowance Dearness allowance Utility allowance Rent free unfurnished accommodation: Higher of; A) Annual value of accommodation PKR 132,000 B) 45% of basic salary PKR 108,000 Company maintained car for personal & official use (5% of PKR 880,000) Leave encashment (N-1) LFA (N-2) Hotel bill for pleasure trip Contribution to provident Fund: (N-3) Employer's contribution PKR 20,000 Less: Exempt up to 10% of salary (N-4) PKR 25,200

PKR
240,000 36,000 36,000 12,000 48,000

132,000 44,000 21,600 21,600 26,400

Total Income
Less: ZAKAT

617,600
(5,000)

612,600

Computation of TAX LIABILITY

Tax on PKR 612,600 @ 4.50% Less: At source Deduction
TARIQ MIR 10

27,567 (25,000)

Taxation Management

NK FACT

Net Tax Payable

N-1: Leave encashment is only exempt for Govt Employees N-2: LFA is fully taxable N-3: Provident fund is assumed to be a recognized PF. N-4: Salary for Provident Fund purposes means Salary plus dearness allowance.

2,567

TARIQ MIR

11