2/15/2020

Salary & Its Taxation [Ch. 5]

Week 3 & 4
Muhammad Imran, FCMA

Agenda 1. Salary & Components

2. Receipt Basis

3. Salaried Person

4. Termination, Arrears,
Tax Free Salary

5. Examples &
Exercises

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Salary- Definition & Scope [Section 12(2)]

Means any amount received by an employee from an employment whether of a revenue or capital nature

Any
and Pay, Wages Any Any Expenditu
or other
includes:
Remuneration
Perquisit Allowanc re
e reimbursed
e by
employer
including leave pay, overtime, whether convertible including cost of living, other than expenditure
bonus, commission, fees, into money or not rent, utilities, education, incurred solely in the
gratuity, work condition entertainment, travelling performance of duties
supplements (such as for the etc. excluding allowance of employment
un-pleasant or dangerous solely expended in the
working conditions) performance of duties
of employment

Some Terms; Dictionary / General Meaning

• Gratuity: A sum of money paid to an employee at the end of a
period of employment.
• Perquisite: A benefit which one enjoys or is entitled to on account of one's job or
position. The casual emolument, fee or profit attached to an office or position in
addition to salary or wages. Perquisite may be cash (such as utility) or in kind
(such as accommodation or motor vehicle provided by the employer to an
employee).

• Annuity: A plan that helps you to get a regular payment for life after
making a lump sum investment. The life insurance company invests
the money of the investor and pays back the returns generated
from it.
• The main difference between an annuity and a pension is that you buy
an annuity after retirement to provide you with a guaranteed regular income,
whereas you save into a pension pot throughout your life. A defined benefit
pension pays you out a regular income for life after retirement.

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Salary- Definition & Scope [Section 12(2)]

Means any amount received by an employee from an employment whether of a revenue or capital nature

Profits Any
and in lieu of, Pension Employ Salary Tax
includes: or in
or ee Share paid by
addition Scheme Employ
to, salary Annuity
er
For entering into an agreement or any supplement any amount of gain earned Amount of tax
of employment, or any to pension or under “Employee Share chargeable on
condition, or changes to annuity received / Scheme employee’s salary
conditions or to a restrictive receivable from and borne by
covenant to any past, present or employer employer.
future employment. Termination
of Employment, P.Fund payments
except employee contribution

Some Terms; Dictionary / General Meaning

• Employee share schemes (also known as employee share purchase
plans or employee equity schemes) give employees:

1. Shares in the company they work for, or

2. The opportunity to buy shares in the company.

Share purchase plans offer eligible employees the chance to

purchase shares, sometimes through a loan from their
employer
• Leave fare assistance (LFA) is an allowance in which a sum of amount is kept
in hold of the monthly salary and at the end of the year the company adds
more amount in it and allows the employees for annual vacations by paying
that total amount.

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Other Definitions as per Income Tax Ordinance 2001

“Employee” means any individual engaged in employment.

“Employer” means any person who engages and remunerates an

employee “Employment” includes:

• a directorship or any other office involved in the management of a
company;
• a position entitling the holder to a fixed or ascertainable
remuneration; or
• the holding or acting in any public office;

Basis of Chargeability- Taxable on Receipt Basis- Sec 12(1)

Salary is taxable on receipt basis i.e. any salary received by an employee

in a tax year (whether advance or arrears of last period) shall be
chargeable to tax in the year of receipt.

A person shall be treated as having received an amount, benefit,

or perquisite if it is
(i) actually received by the person
(ii)applied on behalf of the person, at the instruction of the person or
under any law
(iii)made available to the person.

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Amount or Perquisite when treated received [Sec 12(5)]

Employer Employee

Associate of Employer Associate of Employee

3rd Party under an 3rd Party under an
arrangement arrangement
Past Employer or
Prospective Employer

Exercise

Mr. Bilal, a citizen of Pakistan, is working with PMX (Pvt.) Limited as their
head of treasury for the last 15 years. He has provided you with the
following information for the year ended June 30, 2020.
(i) His salary was Rs. 300,000 per month (inclusive of all allowances) till June
30, 2019, which was increased to Rs. 400,000 P.M effective from 1 July
2019.
(ii) Salary and allowances are deposited into each employee’s bank account
on the 8th working day of the following month.
(iii)On 31 December 2019, Bilal opted for early retirement and final
settlement was made on 8 January 2020.

Required:
Compute Mr. Bilal’s taxable income for the tax year 2020.

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Answer

Mr. BILAL
COMPUTATION OF TAXABLE INCOME
INCOME YEAR ENDED ON 30-06-
2020 TAX YEAR 2020
Salary for month of June received on 08 July 300,000
Six month salary from July 2019 to December 2019 (400,000x6) 2,400,000
Total taxable salary 2,700,000

Note:
Salary is taxed on receipt basis. As salary is transferred on the 8th working
day following the end of the month, salary for the month of June 2019 will
be taxable in the tax year 2020.

Who is a Salaried Person?

A salaried taxpayer means a taxpayer whose salary income constitutes

more than 75% of his total income.

Taxable Salary Exceeds 75% of the Taxable Income = Salaried Case

Taxable Salary is less than 75% of the Taxable Income = Non-Salaried

Case

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Example:

Mr. Zamir has provided the following:

Salary Income Rs. 800,000

Capital Gain Rs. 200,000
Determine whether he is salaried or non-salaried case for rate purposes?

Answer:

Total Taxable Income works out to Rs. 1,000,000

As Salary Income of Mr. Zamir is more than 75% [80% in this case], hence
his income shall be charged under Salaried Category.

Examples:

Basic Salary Totally Taxable

Cost of Living Allowance Totally Taxable
Dearness Allowance Totally Taxable
Leave Fare Assistance Totally Taxable
Leave Encashment Totally Taxable
Overtime Totally Taxable
Commission Totally Taxable
Fee Totally Taxable
Children Education Expenses Totally Taxable
Personal Utility Bills of Employees Totally
Taxable House Employees Cost (Guard, Cook, Driver etc.)
Totally Taxable

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Illustration

Mr. Yasir is working in the scale of Rs. 20,000-2000-30000. At present his

basic salary is Rs. 24,000 / month. During the tax year 2019, he received
from his employer House Rent Allowance @ Rs. 10,000 . Month.
Calculate his Taxable Income.

Solution
Basic Salary (Rs. 24,000 x 12) Rs. 288,000

House Rent Allowance (Rs. 10,000 x 12) Rs. 120,000

Taxable Salary Rs. 408,000

Deductions not allowed [Sec 12(4)]

In computing the income under the head salary, no deduction shall be
allowed for expenses incurred by the employee in earning such
income.

Termination of employment [Sec 12(6)]

If an employee has received compensation on the termination of
employment, the employee may, by notice to Commissioner, elect for
the amount to be taxed at the rate computed as:

The option should be exercised by the due date of furnishing return of income

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135,000

Relief where salary is received in arrears [Sec 12(7)(8)]

In case of receipt of amount under salary which is paid in arrears and is
expected to be charged at rate higher than the rate which would have
been charged if the amount was received in its relevant tax year, the
employee may by a notice to the Commissioner elect for tax rate
applicable in the tax year in which such salary was earned.

The above option shall be exercised by the due date for furnishing
employee’s return of income for the tax year in which the amount
was received or such later date as may be extended by the
Commissioner.

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Tax free salary to employee [Sec 12(3)]- Exercise

The employer of Mr. Usman has undertaken to bear the amount of tax on
his salary income of Rs. 2,000,000.

Compute tax liability of Mr. Usman for the year?

For the sake of simplicity assume that he is liable to pay tax @ 15% of
his taxable income instead of rate mentioned in the first schedule.

Where an employer agrees to pay the tax chargeable on an employee‘s

salary, then the amount so paid shall be treated as an additional benefit to
the employee. The salary income of the employee shall be grossed up by
the amount of tax payable by the employer.

Tax free salary to employee [Sec 12(3)]- Answer

Salary income 2,000,000
Add tax paid by employer (2,000,000 x 15%) 300,000
Taxable salary 2,300,000
Tax liability for the year @ 15% 345,000
Less tax already paid by employer on Usman’s behalf (300,000)
Net tax payable 45,000

However, if the extra tax is also borne by the employer, the gross salary and
the rate applicable have to be worked out again by making addition in two or
three or four steps.

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