Gratuity Exercise

<< Tax treatment of Gratuity

PROVIDENT FUND >>

Taxation Management FIN 623

MODULE 6

LESSON 6.30

SALARY AND ITS COMPUTATION

GRATUITY RECEIVED UNDER SIXTH SCHEDULE

In the case of employees covered by approved gratuity under Sixth Schedule:

Any gratuity received by an employee from a gratuity fund approved by the Commissioner of Income Tax

in accordance with the rules contained in Part III of the Sixth Schedule, is fully exempt under clause (13)(ii),

Part I of Second Schedule.

Exercise-2 on Gratuity:

Mr. A, an employee of a private Company, received Rs. 1,000,000 at the time of retirement on 01-10-2006,

from a gratuity fund approved by the Commissioner of Income Tax under Sixth Schedule.

Other information/data for tax year 2007 is given here under:

1. Basic salary

Rs.360,000

2. Bonus

Rs. 90,000

3. Gardener

Rs. 48,000

Compute taxable income and tax thereon for tax year 2007.

Solution of Exercise 2:

Tax payer: Mr. A

Tax year: 2007

Residential Status: Resident

NTN: 000111

Computation of taxable income and tax thereon:

In Rs

Particulars

Total income

Exempt Income

Taxable Income

Basic Salary

360,000

Nil

360,000

Bonus

90,000

Nil

90,000

Gardener

48,000

Nil

48,000

Gratuity

1,000,000

Nil

Taxable Income

498,000

Tax Liability:

Tax payable = 498,000 x 3.5%=17,430

N-1

Gratuity fund approved by the Commissioner of Income Tax is exempt under Sixth Schedule.

Treatment if Gratuity Approved by Central Board of Revenue

In Case Gratuity Approved Under clause (13)(iii), Part I, Second Schedule-CBR approval

· First gratuity received up to Rs. 200,000 is exempt.

· Amount exceeding Rs. 200,000/- will be taxable as salary.

Treatment of Gratuity not Covered under any other Clause of Part I of 2nd Schedule:

Gratuity received by an employee/family on retirement or death shall be exempt from tax to the extent of

the least of the following:

a. 50% of amount receivable

b. Rs. 75,000

However, this exemption is not available in the following cases:

· If gratuity is received outside Pakistan

· Received by a director of a company who is not a regular employee of the company

· If received by a non resident person

· If recipient has already received any gratuity from the same or any other employer

Exercise-3

Mr. A retired on 01.01.2007, he received gratuity amounting Rs. 600,000. The gratuity fund was not

approved by the authorities stipulated in the ordinance. Explain treatment of gratuity received by the said

employee under the provisions of the Ordinance.

Solution:

Taxation Management FIN 623

As per clause (13)(iv), Part I of Second Schedule, exemption is available as follows:

50% of Rs. 600,000 received = Rs. 300,000 or Rs.75,000, whichever is less.

In this case Rs.75,000 is exempt and balance amount of Rs.225,000 will be taxable.

Gratuity: Points to Remember:

· Gratuity will be ignored while computing taxable income and tax liability of a deceased person.

· In case the gratuity is received by legal heirs, where employee dies before retirement the gratuity would

be taxable in the hands of legal heirs of the deceased.

Pension

Pension is the amount received on account of past services/employment

Tax treatment of Pension

Pension Totally Exempt

If received by a citizen of Pakistan under clause (8) part I of second Schedule. Provided

As stated above the recipient should be citizen of Pakistan

The recipient must not be working for the same employer for any remuneration.

In case a person receives pension from more than one employer, the exemption shall be available to the

higher of the pensions received by him.

Pension Received by Ex-Government Employees and Members of Armed Forces.

Any pension received by employees of federal govt./Provincial govts. Members of Armed Forces of

Pakistan or granted under the rules to their families is exempt from tax under clause (9), part I of second

Schedule

Clauses (8),(9), (12), (16), (17) Part I of Second Schedule.

Clause (8)

Any pension received by a citizen of Pakistan from a former employer, other than where the person

continues to work for the employer (or an associate of the employer).

Provided that where the person receives more than one such pension, the exemption applies only to the

higher of the pensions received.

Clause (9)

Any Pension:

(i) Received in respect of services rendered by a member of the Armed Forces of Pakistan of Federal

Government or a Provincial Government;

(ii) Granted under the relevant rules to the families and dependents of public servants or members of the

Armed Forces of Pakistan who die during service.

Clause (12)

Any payment in the nature of commutation of pension received from Government or under any pension

scheme approved by the Central Board of Revenue for the purpose of the clause.

Clause (16)

Any income derived by the families and dependents of the "Shaheeds" belonging to Pakistan Armed Forces

from the special family pension, dependents** pension or children's allowance.

Clause (17)

Any income derived by the families and dependents of the "Shaheeds" belonging to the Civil Armed Forces

of Pakistan to whom the provisions of the Joint Services Instruction No. 5/66 would have applied had they

belonged to the Pakistan Armed Forces from any like payment made to them.

Exercise on Pension

Mr. A retired on 01-01-2007 and thereafter joined a private Co.

Other information/data for tax year 2007 is given here under:

1. Salary

Rs.600,000

2. Pension

Rs.300,000

Compute taxable income and tax thereon for tax year 2007.

Solution:

In this case taxable income for tax year 2007 will be Rs. 600,000.

Pension from ex-employer is exempt under clause (17), Part I, Second Schedule.

Taxable income = 600,000

Tax payable = 600,000 x 6%= Rs 36,000

Taxation Management FIN 623

Pension Granted to Injured or Disabled:

Pension granted to a public servant or personnel of Armed Forces on injuries or body disability and to

families and dependents of `Shaheeds' belonging to civil or Pakistan Armed Forces; or public servant or

member of Armed Forces, who dies during service is exempt as provided in part I of Second Schedule.

Any payment in the nature of commutation of pension [Clause (12), Part I, 2nd Schedule] is Exempt from

tax:

Any payment in the nature of commutation of pension received from the government or under any pension

scheme approved by the Central Board of Revenue under clause (12), Part I, Second Schedule is exempt

from tax.

Exercise on Commutation of Pension:

Mr. A, a government servant, retired on 1-12-2006 and received Rs.900,000 as commutation of pension.

Compute taxable income for tax year 2007.

Solution:

Commutation of Pension is exempt under clause (12) Part I of Second Schedule.

Exercise- on lump sum payments received:

Mr. A received Rs. 1,500,000 on opting for Golden Handshake in the tax year 2007. He received total

income amounting Rs. 600,000 as salary during said year. Rate of tax for preceding three tax year was 20%,

15% and 10%. Compute taxable income and tax thereon for tax year 2007.

Solution:

Tax payer can opt to seek approval from CIT to charge lump sum payments received in a tax year at

average tax rate of last three years. In this case average tax rate for last three years comes to 15%. So it is

advisable to opt for charging this amount as per procedure prescribed above.

Computation of Tax:

Salary at normal rate = Rs 600,000 x 6%= 36,000

Lump sum payments= 1,500,000 x 15% = 225,000

If lump sum payments of Rs 1,500,000 had been included in salary income, taxable income would have

been 2,100,000 and that would have been charged at the rate of 25% as shown at serial number 14 for

taxable income exceeding 1,300,000.

Tax liability would have been Rs 2,100,000 x 25% that is Rs 525,000. Hence it is advisable for tax payer to

opt for charging the tax at average rate of last three years.

Table of Contents: