Chapter 5: INCOME FROM SALARY

For CAF 02 Tax Practices

Sajjad Ahmed Malik

Faculty Member: RISE Premier School of Accountancy
 Chapter 5: INCOME FROM SALARY

INCOME FROM SALARY

Salary [Sec. 12]

(1) Taxable on receipt basis
Any salary received by an employee, other than exempt salary, shall be chargeable under the
head “Salary”.
(2) Definition and scope of salary
Salary received by an employee from any employment, whether of a revenue or capital nature,
including:
a) any pay, wages or remuneration provided to an employee, including leave pay, payment in
lieu of leave, overtime, bonus, commission, fees, gratuity (will be discussed later) or work
condition supplements (such as for unpleasant or dangerous working conditions):
b) any perquisite (will be discussed later)
c) any allowance provided by an employer including a cost of living, subsistence (paid for being
away from home), rent, utilities, education, entertainment or travel allowance, excluding:
allowances solely expended for performing official duties;
Explanation: Any allowance solely expended in the performance of employee’s duty does not
include:
1. allowance which is paid in monthly salary on fixed basis or percentage of salary or
2. allowance which is not wholly, exclusively, necessarily or actually spent on behalf of the
employer;
d) an expense of an employee that is paid or reimbursed by the employer, other than
reimbursements for performing official duties;
➢ All cash allowances and reimbursement of expenses for any purpose (other than the
performance of official duties) are taxable as salary.
➢ All of the expenses incurred necessarily to meet the official duty are not chargeable to
tax.
➢ But if it is fixed monthly, weekly etc. or is at percentage of salary, it will be taxable as
salary.
e) the amount of any profits in lieu of, or in addition to, salary including any amount received –
i) by a person for agreeing to enter into an employment relationship;
ii) by a person for agreeing to any conditions of employment or any changes to those
conditions;
iii) on termination of employment, including compensation for redundancy or loss of
employment and golden handshake payments;
iv) from a provident or other fund, if it is not a repayment of contribution by the
employee [Provident Fund will be discussed later]; and
v) by a person for agreeing to a restrictive covenant for any past, present or
prospective employment;
f) any pension, annuity (will be discussed later) and
g) Any amount chargeable u/s 14 (employee share scheme).
(3) Tax free salary to employee
Where an employer agrees to pay tax on employee‘s salary, the employee‘s salary income
shall be grossed up by the tax payable by employer
(For practice, try to attempt practice Question 1 to 3 given at page 3 and 4)

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(4) No deduction shall be allowed for an expense paid by an employee under the head “Salary”.
(5) An amount shall be treated as received by an employee if it is paid:
a) By the employee’s employer, an associate of the employer, or a third party under an
arrangement with the employer;
b) by a past or prospective employer; or
c) to the employee or an associate of the employee or a third party under an agreement
with the employee.

(6) An employee who has received an amount on termination of employment, including

compensation for redundancy or loss of employment and golden handshake, may, by notice
to Commissioner, elect for the amount to be taxed at following rate: –
Total tax paid or payable for three preceding tax years x 100
Total taxable income for three preceding tax years
➢ The above option can be exercised by due date of furnishing return of income.
Commissioner may allow a longer period. [S.12 (8)]
Note: If there is a loss, say in one of the 3 preceding tax years then we will take the
average of remaining 2 years.
(For practice, try to attempt Question 4 given at page 4)
(7) Where –
a) any salary is paid to an employee in arrears; and
b) because of this employee’s income is charged at higher rate as compared to the rate
that was applicable
if the salary was paid in the year he rendered the services, he may, give notice to the
Commissioner, and elect the rate applicable in the year in which he earned salary.
➢ The above option can be exercised by due date of furnishing return of income.
Commissioner may allow a longer period. [S.12 (8)]

To explain Sec 12 (1),

When a salary is treated to be received (sec 69)
A person shall be treated as having received an amount, benefit, or perquisite if it is –
a) actually received by the person;
b) applied:
i. on behalf of the person, e.g. employer deducted amount and deposited in a provident fund
ii. at instruction of the person e.g. employee’s club membership fee paid by employer
iii.under any law; e.g. employee makes an default in paying wealth tax and on court order,
employer makes payment
or
c) Made available to the person. e.g. Employer has handed over the cheque to the employee
OR provided benefit in kind i.e. giving AC instead of amount

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Salary is taxable on receipt basis and not on accrual basis.

Ex: 1
Mr. Adnan Rasheed joined the company on August 1, 2020.
Other details:
In TY 2021 his salary per month was Rs. 60,000 and in TY 2022 his salary per month was Rs. 80,000.
Company distributes salary on 7th day of next month.
Required: Calculate his salary income for TY 2021 and 2022

Answer
Salary Income for TY 2021
(10 months x Rs 60,000/month) = Rs. 600,000
Salary Income for TY 2022
(1 months x Rs 60,000/month + 11 month x Rs 80,000/ month) = Rs. 940,000

Ex: 2
In the month of June 2018, BONANZA recorded salary payable in its financial records of an employee Mr. Nazir. The
salary will be paid in the month of July 2018. Is the salary will be assumed as received in June 2018?
Conclusion
No sum is received in June 2018.
(For practice, try to attempt Question 6)

Note: Requirement in all questions is to calculate the tax liability.

Question-1
Mr. Adnan Rasheed provided following:
Basic Salary 300,000/m
House Rent allowance 190,000/m
Tax on salary is to be borne by employer.
Answer: Income from Salary
Basic Salary (300,000 x 12) 3,600,000
House Rent allowance (190,000 x 12) 2,280,000
5,880,000
Add: Tax Benefit (W) 1,948,118
Salary Income 7,828,118

Tax liability (Table 2) (700,000 + 35% of 3,728,118) 2,004,842

Less: Tax already paid by the employer (1,948,118)

Tax payable with return *56,523
*(Ideally it should be Rs. 0 but we have stopped calculation at Step 3 so it is not zero.)
Working:

Step 1 Salary Income 5,880,000

Tax on above (Table 2) (700,000 + 35% of 1,780,000) 1,323,000

Step 2 Salary Income (5,880,000+ 1,323,000) 7,203,000

Tax on above (Table 2) (700,000 + 35% of 3,103,000) 1,786,050

Step 3 Salary Income (5,880,000+ 1,786,050) 7,666,050

Tax on above (Table 2) (700,000 + 35% of 3,566,050) 1,948,118

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Question-2
Mr. Adnan Rasheed provided following:
Basic Salary 300,000/m
House Rent allowance 190,000/m
Capital Gain 400,000
Tax on salary is to be borne by employer.
Answer: Income from Salary
Basic Salary (300,000 x 12) 3,600,000
House Rent allowance (190,000 x 12) 2,280,000
5,880,000
Add: Tax Benefit (W) 1,551,645
Salary Income 7,431,645
Capital Gain 400,000
7,831,645

Tax liability (Table 2) (1,095,000 + 35% of 1,831,645) 1,736,076

Less: Tax already paid by the employer (1,551,645)
Tax payable with return *184,431

Working:

Step 1 Salary Income 5,880,000

Tax on above (Table 2) (435,000 + 27.5% of 2,280,000) 1,062,000
Step 2 Salary Income (5,880,000+ 1,062,000) 6,942,000
Tax on above (Table 2) (1,095,000 + 35% of 942,000) 1,424,000
Step 3 Salary Income (5,880,000+ 1,424,000) 7,304,700
Tax on above (Table 2)(1,095,000 + 35% of 1,304,700) 1,551,645

Question-3
Mr. B provided following detail:
Basic Salary 40,000/m
House Rent allowance 30,000/m
Tax of Rs. 500 will be borne by employer.

Answer:
Basic Salary 480,000
House Rent allowance 360,000
840,000
Add: Tax Benefit 500
Tax able Income 840,500

Tax liability (XXXXXXX) (Table 2) XXXX

Less: Tax paid by employer (500)
Balance tax to be paid XXXXX

Question-4
Mr. A is an employee of ABC company. He has provided you with the following details for TY 2011.
His basic salary is Rs.40,000/month. Dearness allowance is Rs. 2,000/ month and house rent allowance is
Rs. 20,000/month.
He retired on April 30, 2011. Golden Handshake payment received on retirement amounted to Rs. 950,000
Details of preceding four tax years taxable income and tax liability is as follows. Calculate his taxable
income and tax liability.

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Tax Year Taxable Income Tax liability

2008 1,000,000 48,000
2009 800,000 24,000
2010 900,000 36,000
Answer
Treating Golden hand shake receipt in normal way
Income from salary w-2 1,570,000
Taxable income 1,570,000
Tax liability (Table 2) (30,000+15%*350,000) 82,500

Treating Golden hand shake receipt as a separate block

Income from salary w-2 1,570,000
Total income 1,570,000
Less: Golden handshake separate block (950,000)
Taxable income – taxable under NTR 620,000

Tax liability
Tax liability on salary income other than golden hand shake (5%*20000) 1,000
Add: Tax on Golden hand shake (950,000 x (W-1) 4%) 38,000
39,000
As the tax liability is lower in the case the golden shake is treated as a separate block, therefore this option
is feasible for taxpayer.
(Working-1)
Tax Year Taxable Income Tax liability
2008 1,000,000 48,000
2009 800,000 24,000
2010 900,000 36,000
2,700,000 108,000
Average rate (108,000/2,700,000*100) 4.00%

(Working-2)
Income from salary
Basic salary (40,000 x10) 400,000
Dearness allowance (2,000 x10) 20,000
House rent allowance (20,000 x10) 200,000
Golden handshake 950,000
1,570,000

“employee” means any individual engaged in employment;

“employer” means any person who engages and remunerates an employee;
“employment” includes –
(a) a directorship or other office involved in the management of a company (director
receiving any fee for his/her time in management affairs) ;
(b) a position which gives the employee a fixed or ascertainable remuneration (sales
commission etc); or
(c) the holding or acting in any public office (e.g. MNA, MPAs);

Note:
It’s important that master servant relationship exists between the person who is using the
service and the person who is rendering the service. If it does not exist, it will not be treated as
an employment, rather it will be considered as independent service rendered to the person who
has hired him.
Example:
a) Mr. A is Laptop mechanic on payroll of company X, receives Rs. 40,000 from X is salary.

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b) Mr. A repairs laptop of a Mr. B at his home and receives Rs. 2000 is payment against
services not salary.
c) Company X gets its one of laptop repaired from Hall Road and pays against it, it is
payment against services not against salary.

Value of perquisites [Sec. 13]

(3) Rule 5-Income Tax Rules 2002
Following will be added in the income if employer has provided employee a motor vehicle
in a tax year:
Partly for personal and 5% of
partly for official use (a) the cost to the employer for acquiring the motor vehicle; or
(b) The fair market value of the motor vehicle at the
commencement of the lease, if it is taken on lease.
For personal use only 10% of
(a) the cost to the employer for acquiring the motor vehicle; or
(b) The fair market value of the motor vehicle at the
commencement of the lease, if it is taken on lease.
For official use 0%
➢ Running and maintenance benefit for car will be separately taxable.
➢ For above rule, “employee” includes a director of a company.
➢ If in the question, it is mentioned that employee is paying anything to
employer in respect of service availed then this will not be deducted because as per
law only 10% or 5% is to be added as the case may be. Example: Chapter: Income
Tax Numerical (September 2011)

➢
Question-1 Car acquired through purchase (by the employer)
Mr. Naveed Ansari is a director of Rise college pvt. Ltd. The company has provided him a car as a part of
his salary package. The cost of the car purchased by company is Rs. 4,000,000.
Req: What amount to be added to salary of him if the car has been provided for personal use only.
Answer-1
Amount to be added in salary income (10% x Rs. 4,000,000) 400,000

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Question-2: what will be your answer if data is same as of question 1 and car is being used for private
and official use.
Answer-
Amount to be added in salary income (5% x Rs. 4,000,000) 200,000

Question-3 Car acquired on lease (by the employer)

Mr. Naveed Ansari is a director of Rise college pvt. Ltd. The company has provided him a car as a part of
his salary package. The fair market value of the car is Rs. 4,000,000 at the inception of lease. Gross lease
rentals payable by the employer amounts to Rs. 110,000 per month for five years. Compute the amounts
to be added in the salary income of Mr. Ansari if:
(a) The car has been provided for both official and personal use
(b) The car has been provided for personal use only.
Answer-3
(a) Amount to be added in salary income: (5% x Rs. 4,000,000) 200,000
(b) Amount to be added in salary income: (10% x Rs. 4,000,000) 400,000

Note: Answer-3
Value (for the purpose of Rule 5) on the basis of gross lease rentals is irrelevant i.e. Rs. 6,600,000 (110,000
per month x 12 months x 5 years) is irrelevant. We will use fair market value at the inception of lease.

(5)Where, the services of a housekeeper, driver, gardener or other domestic assistant are
provided by an employer to an employee, the following shall be added in the salary income:
- the salary paid by employer to person providing service less amount paid by employee
to employer.
“services” includes the provision of any facility;

(6) If utilities are provided by an employer to an employee, the “Salary” shall include the fair
market value of the utilities less amount paid by the employee to employer.
“utilities” includes electricity, gas, water and telephone.

Question
Mr. Imran Khan is working as an officer in a company and he has been provided with following benefits
apart from basic salary of Rs. 100,000 per month.
Driver 12,000 per month
Cook 8,000 per month
Gardener 8,000 per month
The above payment to driver, gardener and cook is made by the company directly. Mr. Khan pays to the
company Rs. 3,000 per month in respect of services of Gardener.
Required: Compute the amount of taxable salary for the tax year

Answer
Basic Salary (100,000 x 12) 1,200,000
Benefits:
Driver: (12,000 x 12) 144,000
Cook (8,000 x 12) 96,000
Gardener (8,000-3,000) x 12) 60,000

Taxable income from salary 1,500,000

Question
Mr. Zahid Qavi is working for ABC Limited. Cost of Mr. Zahid’s utilities is to be borne by company and he
has to pay a nominal amount of Rs. 2,000 per month. The actual cost incurred by employer in whole of the
tax year for utilities for Mr. zahid is as follows:

Water 100,000

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Electricity 200,000
Gas 30,000
Basic salary per month is Rs. 50,000. Calculate taxable income.
Answer
Basic salary (50,000 x 12) 600,000
Cost incurred by employer (100,000 + 200,000 + 30,000) 330,000
Less: Paid by employee to employer (2,000 x12) (24,000) 306,000
Taxable income 906,000

(7) Interest free/concessional loan

Where a loan is provided by an employer to an employee, the salary shall include-
Scenario Amount to be added in salary income
Where no profit (interest) on Interest on loan calculated at bench mark rate
loan is paid by an employee
Where profit (interest) on loan The difference between the profit on loan paid
paid by employee is less than by the employee and profit on loan computed at
benchmark rate the benchmark rate
However nothing will be added in the salary income if:
• the loan is upto Rs. 1,000,000.
• the interest benefit is arising because employee has waived the interest to employer
when employee had provided the loan to the employer. (for example as in case of
provident fund sometimes)

“BENCHMARK RATE” MEANS --

(i) for the tax year 2003, a rate of 5% per annum; and
(ii) the rate for each coming year will be increased by 1%, but a cap will be placed at 10%.
So rate for current and coming years is fix at 10%.
Question
Mr. Waqar is an employee of ABC company. Mr. Waqar has availed a loan of Rs. 2,000,000 in tax year 2022.
What amount shall be added into his income from salary on following alternate assumptions:
(a). No profit on loan is payable to company by Mr. waqar
(b). Profit is payable to company at 6% per annum
(c). Profit is payable to company at 18% per annum
Answer
(a) Amount to be added in salary income on account of profit on loan. 200,000
(Rs. 2,000,000 x 10%)
(b) Amount to be added in salary income on account of profit on loan. 80,000
[Rs. 2,000,000 x (10%-6%)]
(c) Nothing will be added in his income.

(8) Where employee uses a loan obtained from employer for acquisition of any asset or
property producing income under any head of income, it will be assumed that employee
has paid profit (interest) equal to the benchmark rate.
Question
Mr. Asim has obtained a loan of Rs. 1,600,000 from employer on February 1, 2013 for the purpose of
purchasing a shop for his business. The interest charged by employer on this loan is 4% per annum. He has
provided you following details regarding TY 2013.
Details regarding business income
Revenue earned from business 1,200,000
Expenses incurred 300,000
Details regarding salary income
Basic salary per month 50,000
Hose rent allowance per month 30,000

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Required: Calculate his taxable income?

Answer
Income from salary
Basic Salary (50,000 x 12) 600,000
House rent allowance (30,000 x 12) 360,000
Interest benefit on loan (1,600,000 x (10%-4%) x 5/12) 40,000 1,000,000

Income from business

Revenue earned from business 1,200,000
Less: Expenses incurred (300,000)
Less: Interest on loan calculated at
benchmark rate (1,600,000 x 10% x 5/12) (66,667) 833,333
1,833,333
Note: If in above case interest charged by employer is higher than bench mark rate, than
actual interest paid will be allowed as expense.

(9) Where an obligation of an employee towards employer is waived by the employer, it will
be added in salary.
Obligation of employees may the following:
• Loan received by an employee
• Goods or services purchased on credit by employee

Question
Mr. Anjum was entitled to the following during the tax year 2010 from his employer
Basic Salary for the tax year: 520,000
Education Allowance; 100,000
Mr. Anjum obtained loan from his employer in tax year 2005 amounting to Rs. 400,000 but was unable to
pay till now. His employer has decided to waive the loan.
Required:
Compute the taxable income from salary of Mr. Anjum?
Answer
Basic Salary for the tax year 520,000
Education Allowance 100,000
Loan waived by the employer 400,000
Taxable income from salary 1,020,000

(10)Where an obligation of an employee towards a third party is paid by the employer, it will
be added in salary.

Question
Suppose in above example, Mr. Anjum also obtained loan from a Bank in tax year 2005 amounting to Rs.
380,000 but was unable to pay till present tax year. As a benefit, his employer has decided to pay the loan as
well. Compute the taxable income from salary of Mr. Anjum for the tax year.

Answer
Salary for the tax year 520,000
Education Allowance 100,000
Loan waived by the employer 400,000
Loan paid to the bank by the employer on Mr. Anjum’s behalf 380,000
Taxable income from salary 1,400,000

(11) Where a property is transferred or services are provided by an employer to an employee,

salary shall include:

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- Fair market value of property at the time of transfer less amount paid by employee to
the employer.
- Fair market value of service at the time it is provided less amount paid by employee to
the employer.
Question-1
Employer of Mr. Waqar agrees to provide pick and drop service from school to his home for his children.
The monthly expenditure for the employer in this regard amounts to Rs. 15,000.
Rs. 180,000 (15,000 x 12 months) shall be added in the salary income of the Mr. Waqar.
Question-2
Suppose Mr. Waqar pays Rs. 2,000 per month on account of pick and drop service provided by the
employer. Amount to be added in income from salary shall be computed as follows:
mount paid by employer: 180,000
Less: Amount paid by Mr. Ahsan: (2,000 x 12 months) (24,000)
Amount to be added in income from salary 156,000
Question-3
XYZ company has gifted a plot of land to its employee Mr. A on June 10, 2010 and its market value is
Rs. 500,000. This will be added in his salary income in TY 2010.

(12) Valuation of Accommodation [Rule 4 of Income Tax Rules, 2002]

The value of accommodation provided by an employer to the employee shall be higher
of:
▪ 45% of the minimum of the time scale of the basic salary or the basic salary or
▪ Amount that would have been paid by employer had no accommodation been
provided
Employee includes a director of a company.
Note for students: If “Amount that would have been paid by employer had no accommodation been
provided” is not given in exam than we will compare 45% of basic salary with fair market rental of property
(if it is given).

Minimum of time scale

It is the amount from where the salary scale of an employee starts e.g. (50,000-10,000-90,000) means
salary will starts with Rs. 50,000 with increment of Rs. 10,000 per annum upto maximum of Rs. 90,000.

Where house rent allowance is admissible @ 30% then in above provision 45% will be
replaced with 30%. (Note for student: It is not general rule. It is applicable for certain
Government employees if question specifically refers to it.)
Example-1
Basic salary of an employee is Rs. 100,000/ month. Employer has provided employee with 2 options:
1. Either I will provide you house in factory premises or
2. I’ll give you house rent allowance of 50,000/month.
Employee has opted for home.
Calculate taxable income?
Solution:
Basic salary (100,000 x 12) 1,200,000
Accommodation provided: (Higher of)
-45% of basic salary (1,200,000 x 45% ) or 540,000
- Amount that would have been paid (50,000 x 12 = 600,000) 600,000 600,000
Taxable income 1,800,000

Example-2
Basic salary of Mr. Farhan is Rs. 100,000/ month. Employer has provided employee with a home.
Calculate taxable income?

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Solution:
Basic salary (100,000 x 12) 1,200,000
Accommodation provided (45% of 1,200,000) 540,000
Taxable income 1,740,000
Note: As a general rule higher of 45% of Basic Salary or the amount that would have been paid had no
accommodation been provided is added in salary. The later one is not given. Hence, only 45% of basic
salary is added.
Example-3
An employees is paid a basic salary of Rs.90,000 per month. Employer has provided the employee with a
furnished house. The house is not owned by the employer. Fair market rent of the house is Rs.32,000 per
month.
Solution:
Basic Salary (90,000 x 12) 1,080,000
Accommodation provided: (Higher of)
- 45% of basic salary (1,080,000 x 45%) 486,000
or – Fair market rent (32,000 x 12 =) 384,000 486,000
1,566,000

Note 1:
The accommodation can be either furnished (with furniture) or non-furnished (without furniture). There
is no difference in tax treatment of both of these.
Example-4
Mr. Mather is an employee of ABC company. He has provided you with the following details for TY 2011.
He joined on August 1, 2010.
His basic salary per month is Rs. 40,000 and education allowance and entertainment allowance of
Rs. 5,000/month and Rs. 6,000/month respectively.
Employer has offered him two options either to take home or take a monthly cash allowance of Rs. 20,000.
Mr. Mather has opted for home.
He is allowed to use the electricity, telephone and water facility in home on nominal amount of Rs. 1,000
per month charged by his employer against all of these facilities. However he pays gas bill himself. The
actual amount of bills during TY 2011.
Electricity 20,000
Telephone 30,000
Gas 10,000
Water 6,000
Calculate his taxable income?
Answer-4
Basic salary (40,000 x11) 440,000
Education allowance (5,000 x11) 55,000
Entertainment allowance (6,000 x11) 66,000
Accommodation facility
Higher of: - 45 % of Basic salary (440,000x45%) 198,000
Or - Amount that would have been paid had no accommodation provided
(20,000x11) 220,000 220,000
Utilities excluding gas
Electricity 20,000
Telephone 30,000
Water 6,000
Less: Paid by employee to employer (1,000 x 11) (11,000) 45,000
Taxable income 826,000

Example-5
Mr. Ramzan is an employee of Pink Panther company. He has provided you with the following details for
TY 2011. He joined on September 1, 2010.
His basic salary per month is Rs. 40,000 and education allowance and entertainment allowance of
Rs. 5,000/month and Rs. 6,000/month respectively.
Employer has offered him two options either to take home in factory premises or take a monthly cash
allowance of Rs. 20,000/month. Mr. Uzair has opted for monthly cash allowance.

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Calculate his taxable income?

Answer-5
Basic salary (40,000 x10) 400,000
Education allowance (5,000 x10) 50,000
Entertainment allowance (6,000 x10) 60,000
House rent allowance (20,000x10)
200,000
Taxable income 710,000

Self hiring of property [S. 15(5)]

If employee or his spouse owns a house which is given on rent to the employer and the
employer has provided the same house to employee as rent free accommodation, then it will
have two fold effect:
• Rent actually received by employee from employer will be income from property. (Fair
market rent will be ignored) (Chapter Income from Property)
• It will be a perquisite in the form of accommodation 45% of basic salary will be added
under the head salary.

(13) Where an employer has provided a perquisite which is not covered above
(Laptop/oven/ washing machine/ Fridge etc.), the “Salary income” shall include the fair
market value of the perquisite at the time it is provided, less amount paid by the
employee.

Employee share schemes [Sec. 14]

“Employee share scheme” means any agreement under which a company may issue shares in
the company to:
(a) an employee of the company or an employee of an associated company; or
(b) the trustee of a trust and the trustee may transfer the shares to an employee of
the company or an employee of an associated company.
Basic understanding of operation of employee share scheme
(a) Terminologies
i. Right /Option Simply, A letter stating that employee has a right to
acquire shares at a particular rate
ii. Exercise of right/ Person with the right letter purchases the shares at
Purchase of shares the rate mentioned in the right letter. He then
becomes the owner of shares.
iii. Face value of a The denomination of the share. Generally it is Rs. 10
share per share.
iv. Market value of a Price at which the share is traded in the stock
share market. This may be less than, equal to or more than
face value.
(b) Following events take place in employee shares scheme
Announcement of scheme →Issuance of Right letter→Exercise of right or Issuance of
shares by the company
(1) Value of right/option (Taxability at time of grant of right or option)
The value of a right or option to acquire shares under an employee share scheme is not
chargeable to tax.
(5) Disposal of right or option/ Sale of right or option
Where, in a tax year, an employee disposes of a right or option to acquire shares under
an employee share scheme, the amount chargeable under the head “Salary” shall include the
amount of any gain as calculated below:–

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A-B
where –
A is the consideration received for the disposal of the right or option; and
B is the employee’s cost in respect of the right or option.
Formula for disposal of right
Consideration received for the disposal of the right or option xxx
Less: Cost of right or option (xxx)
xxx
(2) Exercise of right/Acquisition of shares/Issue of shares by company
Where shares are issued to an employee under an employee share scheme (including as
a result of the exercise of an option), following amount is chargeable:
- the fair market value of the shares at the date of issue less consideration given by the
employee for the shares and for rights or options.
Formula for exercise of right

fair market value of the shares at the date of issue xxx

Less: Cost of share (xxx)
Less: Cost of right (xxx)
xxx
(3) Shares issued by company with restriction on transfer
Where shares are issued to an employee under an employee share scheme and there is a
restriction on the transfer nothing will be added in the income until the employee has a
free right to transfer the shares. On getting the free right to transfer, the salary shall
include the fair market value of the shares at the time the employee has a free right to
transfer the shares less consideration given by the employee for the shares and for rights
or options.
However if the employee disposes off the shares before getting the free right to transfer
the shares, the salary shall include the fair market value of the shares at the time the
employee disposes of the shares less consideration given by the employee for the shares
and for rights or options.
(4) Calculation of cost of shares for computing Tax credit / capital gain at the time of disposal
The cost of the shares shall be sum of –
(a) the consideration given by the employee for the shares;
(b) the consideration given by the employee for the grant of right or option; and
(c) the amount chargeable to tax under the head “Salary”.
[For details refer examples of Employee share scheme-chapter Capital Gain ]
Note
1. In case of disposal of shares of private company, gain will be chargeable under the
head capital gain.
2. In case of disposal of shares of public company, gain will be taxed as separate block
because shares of public company fall under the definition of securities.

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Chapter 5: INCOME FROM SALARY

Foreign source salary of resident individuals [Sec. 102]

(1) Any foreign-source salary received by a resident individual shall be exempt if the
individual has paid foreign income tax on salary.
(2) It will be assumed that resident individual has paid foreign income tax if tax is withheld
from salary by the employer and paid to the revenue authority of the foreign country.
Question
Mr. Imran a citizen of Pakistan is employed in XYZ company. He worked in XYZ company from Jul 1, 2010
to January 31, 2011. He got a job in Nepal where he joined on February 1, 2011. His monthly salary in
Pakistan is Rs. 60,000 per month. His monthly salary in Nepal is Rs. 90,000 in Pak rupees. On May 31, 2011
he decided to resign from the Nepalian job and came back in Pakistan on the same date. Since then he has
yet not got any job. He has duly paid the tax to Nepalian Government authorities on his income earned
there.
Calculate his taxable income for TY 2011?
Answer
Salary income (PSI) (60,000x7) 420,000
Salary income (FSI) Exempt -
Taxable Income 420,000
Foreign source salary income is exempt because he has duly paid the tax on it.

[Section 51(2)]
Where a citizen of Pakistan leaves Pakistan during a tax year and remains abroad during a tax
year than salary income earned outside Pakistan during that year shall be exempt from tax.

Note: In such case even if no tax is paid the foreign source salary income will remain exempt.
Question-1
Mr. Arslan a citizen of Pakistan is employed in XYZ company. He worked in XYZ company from Jul 1, 2010 to
January 31, 2011. He got a job in Saudi Arabia where he joined on March 1, 2011. He departed from Pakistan on
February 20, 2011. His monthly salary in Pakistan is Rs. 50,000 per month. His monthly salary in Saudi Arabia is
Rs. 80,000 in Pak rupees. As on June 30th he was still in Saudi Arabia. He did not paid any tax on his salary in
Saudi Arabia. Calculate his taxable income?
Answer-1
Salary income (PSI) (50,000x7) 350,000
Salary income (FSI) Exempt -
Taxable Income 350,000
Because Arslan remained outside Pakistan at the end of tax year, therefore his foreign source salary income is
exempt from tax irrespective of whether he has paid foreign income tax or not.
Question-2
Mr. Amjad a citizen of Pakistan is employed in XYZ company. He worked in XYZ company from Jul 1, 2010 to
January 31, 2011. He got a job in Saudi Arabia where he joined on March 1, 2011. He departed from Pakistan on
February 20, 2011. His monthly salary in Pakistan is Rs. 50,000 per month. His monthly salary in Saudi Arabia is
Rs. 80,000 in Pak rupees. On May 31, 2011 he decided to resign from the Saudi job and came back in Pakistan on
the same date. Since then he has yet not got any job. He did not paid any tax on his salary in Saudi Arabia as there
is no tax on salaries there.
Calculate his taxable income for TY 2011?
Answer-2
Salary income (PSI) (50,000x7) 350,000
Salary income (FSI) (80,000x3) 240,000
Taxable Income 590,000
Because Amjad did not remain outside Pakistan at the end of tax year, therefore his foreign source salary income
is chargeable to tax.

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Chapter 5: INCOME FROM SALARY

Important Exemptions (including those covered in Second Schedule Part 1)

Various terms to be understood before reading exemptions taxation and retirement benefits:
1. Pension: It is a series of monthly payment after the retirement of an employee.
2. Commutation of pension: It is a lump-sum payment of a certain portion of pension for
certain years, paid in advance to employee at the time of retirement.
3. Provident Fund: It will be discussed in upcoming paras.
4.Gratuity: detail in coming paragraphs
Example
An Employee worked for 10 years from age of 35-45 years. His salary at the time of retirement for the month of
December was Rs.30,000. He is entitled to gratuity on the basis of last drawn gross salary multiplied by number
of years worked. Calculate gratuity payable?
Solution
Gratuity = Number of years x last drawn gross salary
=10 x Rs.30,000
=Rs. 300,000

Pension:
➢ Any pension received by a citizen of Pakistan from a former employer shall be exempt.
➢ If person continues to work for the employer (or an associate of the employer) then it
will be chargeable.
➢ If a person receives more than one pension, then only higher pension will be exempt.
➢ If a person’s age is more than 60 years than all pensions shall be exempt irrespective of
above mentioned conditions.
➢ Pension received by employee of Armed forces or Federal or Provincial Government is
exempt.
Mr. A is working as CFO in Bahria Traders since 2009. From 1990 to 2000 he worked for a private hospital and
from 2001 to 2008 he worked for a private school. In TY 2011 he received pension of
Rs. 5,000/month from private hospital and Rs. 6,000/month from private school. Rs. 60,000 (5,000 x 12) will
be added in his salary income. Rs. 72,000 (6,000 x 12) will be exempt.

(12) Commutation of pension received from Government or pension scheme approved by

Board shall be exempt.
(13) Gratuity or commutation of pension received on retirement or, in the event of his death,
by his heirs:
(i) Government employees Fully exempt
(ii) Gratuity fund approved by Fully exempt
Commissioner
(iii) Gratuity scheme approved Exempt upto Rs. 300,000 if scheme is applicable to all
by the Board employees
(iv) -Unapproved gratuity In the case of any employee to whom sub-clause (i),(ii) and (iii)
-Unapproved do not apply, the amount exempt will be lower of following;
commutation of pension - 50% of the amount receivable or
- Rs. 75,000
[above columns are part of syllabus]

The exemption on Unapproved gratuity or Unapproved commutation of pension shall apply if

following conditions are fulfilled:
(a) payment is received in Pakistan;
(b) in case of director, payment is received by him being a regular employee;
(c) payment is received by a resident; and
(d) to gratuity received by an employee who has not received any gratuity from the same or
any other employer.

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Chapter 5: INCOME FROM SALARY

Question-1
Mr. Arslan is employed in XYZ company. His basic salary is Rs.40,000/month. In TY 2011 he resigned on March
31, 2011 and received Rs. 90,000 from unapproved gratuity fund.
Answer-1
Basic salary (40,000 x 9) 360,000
Gratuity 90,000
Exempt up to lower of: 75,000
50% of 90,000 = 45,000 (45,000) 45,000
Taxable Income 405,000

Question-2
Mr. Asim is employed in XYZ company. His basic salary is Rs.40,000/month. In TY 2011 he resigned on March
31, 2011 and received Rs. 470,000 from gratuity scheme approved by FBR and Rs. 200,000 commutation of
pension(un approved).
Answer-2
Basic salary (40,000x9) 360,000
Gratuity scheme 470,000
Exempt up to (300,000) 170,000

Unapproved commutation of pension 200,000

Exempt up to lower of: 75,000
50% of 200,000 = 100,000 (75,000) 125,000
Taxable Income 655,000
(24) Benevolent fund
Any benevolent grant paid from a Benevolent Fund to employees or members of their
families is exempt.
(53A) The following perquisites received by an employee shall be exempt:-
(ii) Free or subsidized food provided by hotels and restaurants to its employees during
duty hours;
(iii) Free or subsidized education provided by an educational institution to the children of
employees;
(iv) free or subsidized medical treatment provided by a hospital/clinic to its employees; and
(v) other benefit for which the employer do not bear any marginal cost, as notified by Board.
Question-1
Mr. Arham is teaching in Rise college. His basic salary is Rs.40,000/month. Dearness allowance is Rs. 2,000/
month and house rent allowance is Rs. 6,000/month. His child is also getting education in same college. College
charges a concessional fee of Rs. 40,000 per annum against the market charge of Rs. 65,000. Calculate income.
Answer-1
Basic salary (40,000x12) 480,000
Dearness allowance (2,000x12) 24,000
House rent allowance (6,000x12) 72,000
Taxable Income 576,000
Subsidized education provided by the college is exempt under clause 53A of Part-1 Second Schedule.

(139) Medical facility/reimbursement or medical allowance

Types Tax treatment
1. Medical facility/Reimbursement of medical Exempt (Provided that National Tax
expenses is provided as per terms of Number of the hospital or clinic, as
employment the case may be, is given and the
employer also certifies and attests the
medical or hospital bills)
2. Medical facility/Reimbursement of medical Fully taxable
expenses
not as per terms of employment

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Chapter 5: INCOME FROM SALARY

3. Only Medical allowance Exempt upto 10% of basic salary.

4. Medical allowance + Medical facility/ Allowance is fully taxable.
Reimbursement of medical expenses in Facility/Reimbursement will be
accordance with terms of employment exempt.
5. Medical allowance + Medical facility/ Allowance is exempt upto 10% of basic
Reimbursement of medical expenses not in salary. Facility/Reimbursement will be
accordance with terms of employment fully taxable.

Exam note:
1. The term medical facility (hospitalization) comprises of the following scenarios:
a) Medical insurance for hospitalization is borne by employer;
b) Reimbursement of medical expense on account of hospitalization is made by
employer;
c) Hospitalization is provided by insurance policy;
d)Personal medical expenses of employee are reimbursed by employer; and
e) Free medical treatment is provided by employer to employee.
2. If in income from salary question, both medical allowance and medical facility are
given and medical facility is as per terms, medical allowance will be fully taxable and
facility will be exempt.
Question-1
Basic salary of Mr. Zaryab is Rs.40,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. As per the terms of employment he is entitled for free hospitalization for which
employer incurred cost of Rs. 30,000.
Calculate his taxable income?
Answer-1
Basic salary (40,000 x12) 480,000
Dearness allowance (4,000 x 12) 48,000
House rent allowance (6,000 x 12) 72,000
Hospitalization (Exempt being as per terms of employment) -
Taxable Income 600,000
Question-2
Basic salary of Mr. Ali Butt is Rs.40,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. Medical allowance is 15% of basic salary.
Calculate his taxable income?
Answer-2
Basic salary (40,000 x 12) 480,000
Dearness allowance (4,000 x 12) 48,000
House rent allowance (6,000 x 12) 72,000
Medical allowance (480,000 x 15%) 72,000 -
Less: Exempt upto 10% of basic salary (480,000 x 10%) (48,000) 24,000
Taxable Income 624,000

Question-3
Basic salary of Mr. Arman Khan is Rs.40,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. As per the terms of employment he is entitled for free hospitalization for which
employer incurred cost of Rs. 30,000 which is in addition to medical allowance of Rs. 3,000/month.
Calculate his taxable income?
Answer-3
Basic salary (40,000x12) 480,000
Dearness allowance (4,000x12) 48,000
House rent allowance (6,000x12) 72,000
Medical allowance (Fully taxable) (3,000x12) 36,000
Hospitalization (Exempt being as per terms) -
Taxable Income 636,000

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Chapter 5: INCOME FROM SALARY

Question-4
Basic salary of Mr. Anzah is Rs.40,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. Medical allowance is Rs. 5,000/month. Free hospitalization provided cost Rs.
50,000 which is not as per terms of employment.
Calculate his taxable income?

Answer-4
Basic salary (40,000x12) 480,000
Dearness allowance (4,000x12) 48,000
House rent allowance (6,000x12) 72,000
Hospitalization (Chargeable being not as per terms) 50,000
Medical allowance (5,000x12) 60,000 -
Less: Exempt upto 10% of basic salary (480,000x10%) (48,000) 12,000
Taxable Income 662,000
Leave Encashment (Clause 19 Part 1 of 2nd Schedule)
Any amount received on encashment of leave preparatory to retirement is exempt, if received
by a Government employee & member of Armed Forces of Pakistan
Worker’s Profit Participation Fund (WPPF) (Clause 26 Part 1 of 2nd Schedule)
It is fully exempt.
Taxation of Provident Fund
a. Recognized Provident Fund
Employee contribution
No treatment as the amount is paid from salary.
Employer’s contribution (Clause 3 Part 1 of 6th Schedule)
Employer’s contribution to fund is exempt upto lower of:
• 1/10th of salary* or
• Rs. 150,000
Interest on Fund balance (Clause 3 Part 1 of 6th Schedule)
Interest is exempt upto higher of:
• 1/3rd of salary* or
• Interest calculated at 16%.
Accumulated balance (Clause 4 Part 1 of 6th Schedule)
Whole of the receipt is exempt.
*“Salary" for the purposes of provident fund means basic salary and dearness allowance.
(it excludes all other allowances and perquisites).
Question-1
Basic salary of Mr. Abu bakar is Rs.40,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. Employee contribution in provident fund is Rs. 4,000/month and the same
amount is contributed by the employer. Interest credited during the year is Rs. 18,000 at the rate of 18% per
annum. The fund is recognized. Calculate taxable income?
Answer-1
Basic salary (40,000x12) 480,000
Dearness allowance (4,000x12) 48,000
House rent allowance (6,000x12) 72,000
Employer’s contribution (4,000x12) 48,000
Less: Exempt upto lower of:
- 150,000
- 52,800 {1/10th of (480,000+48,000)} (52,800) -
Interest on provident fund 18,000
Less: Exempt upto higher of:
- 16,000 (18,000/18x16)
- 176,000 {1/3rd of (480,000+48,000)} (176,000 -
)
Taxable Income 600,000

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Chapter 5: INCOME FROM SALARY

Question-2
Basic salary of Mr. Junaid is Rs.20,000/month. Dearness allowance is Rs. 4,000/ month and house rent
allowance is Rs. 6,000/month. Employee contribution in provident fund is Rs. 6,000/month and the same
amount is contributed by the employer. Interest credited during the year is Rs. 100,000 at the rate of 14 % per
annum. The fund is recognized. Calculate taxable income.
Answer-2
Basic salary (20,000x12) 240,000
Dearness allowance (4,000x12) 48,000
House rent allowance (6,000x12) 72,000
Employer’s contribution (6,000x12) 72,000
Less: Exempt upto lower of:
- 150,000
- 28,800 {1/10th of (240,000+48,000)} (28,800) 43,200

Interest on provident fund 100,000

Less: Exempt upto higher of:
- 114,286 (100,000/14x16)
- 96,000 {1/3rd of (240,000+48,000)} (114,286) -
Taxable Income 403,200

Question-3
Basic salary of Mr. Irfan is Rs.20,000/month. Dearness allowance is Rs. 4,000/ month and entertainment
allowance is Rs. 6,000/month. Employee contribution in provident fund is Rs. 6,000/month and the same
amount is contributed by the employer. Interest credited during the year is Rs. 100,000. The fund is recognized.
Calculate taxable income.

Answer-3
Basic salary (20,000x12) 240,000
Dearness allowance (4,000x12) 48,000
Entertainment allowance (6,000x12) 72,000
Employers contribution (6,000x12) 72,000
Less: Exempt upto lower of:
- 150,000
- 28,800 {1/10th of (240,000+48,000)} (28,800) 43,200

Interest on provident fund 100,000

Less: Exempt upto {1/3rd of (240,000+48,000)} (96,000) 4,000
Taxable Income 407,200
Note: If rate of interest is not given we will simply compare with 1/3 of salary.

Question-4
Mr. Babar is an employee of ABC company. He has provided you with the following details for TY 2011. His basic
salary is Rs.40,000/month. Dearness allowance is Rs. 2,000/ month and house rent allowance is Rs.
6,000/month. Employee contribution in provident fund is Rs. 4,000/month and the same amount is contributed
by the employer. Interest credited during the year is Rs. 40,000 at the rate of 18 % per annum. He decided to
retire with effect from April 30, 2011.The fund is recognized under 6 th Schedule of ITO, 2001. At the time of
retirement he received Rs. 800,000 which has been accumulated in the fund over the years. It comprised of the
following.
Employer contribution to date 300,000
Employee contribution to date 300,000
Interest to date 200,000
800,000
Calculate his taxable income?
Answer-4
Basic salary (40,000x10) 400,000
Dearness allowance (2,000x10) 20,000
House rent allowance (6,000x10) 60,000

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Chapter 5: INCOME FROM SALARY

Employer’s contribution (4,000x10) 40,000

Less: Exempt upto lower of:
- 150,000
- 42,000 {1/10th of (400,000+20,000)} (42,000) -

Interest on provident fund 40,000

Less: Exempt upto higher of:
- 35,556 (40,000/18x16)
- 140,000 {1/3rd of (400,000+20,000)} (140,000) -

Taxable Income 480,000

Accumulated balance is exempt.

b. Government Provident Fund

Employee contribution
No treatment as the amount is paid from salary.
Employer’s contribution and Interest on Fund balance
It is exempt under income tax ordinance 2001.
Payment of accumulated balance
It is exempt under income tax ordinance 2001.

Question-1
Mr. Ahsan is an employee of Federal Government. His basic salary is Rs.40,000/month. Dearness allowance is
Rs. 2,000/ month and house rent allowance is Rs. 6,000/month. Employee contribution in provident fund is
Rs. 4,000/month and the same amount is contributed by the employer. Interest credited during the year is Rs.
18,000 at the rate of 18 % per annum. Calculate taxable income.
Answer-1
Basic salary (40,000x12) 480,000
Dearness allowance (2,000x12) 24,000
House rent allowance (6,000x12) 72,000
Taxable Income 576,000
Employer’s contribution and interest credited on fund is fully exempt because the fund is a Government
Provident fund.
c. Unrecognized Provident Fund
Employee contribution
No treatment as the amount is paid from salary.
Employer’s contribution and Interest on Fund balance
It will not be taxed in each year.
Payment of accumulated balance
Whole of the employer’s contribution to date along with interest will be taxable.
(Final amount received – whole employee contribution)
Comprehensive Question relating to Provident Fund
Mr. Safdar got retired on 31st March, 2012 and has provided the following data:
2010 2011 2012
Rs. Rs. Rs.
Basic salary/Month 70,000 80,000 90,000
Dearness allowance/month 10,000 15,000 20,000
House rent allowance/month 30,000 35,000 40,000

Other data regarding provident fund: 2010 2011 2012 Total

Employer contribution 126,000 144,000 121,500 391,500
Employee contribution 126,000 144,000 121,500 391,500
Interest thereon 40,000 60,000 58,000 158,000
Interest is credited @ 17%.
Required:
Calculate taxable income assuming:

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Chapter 5: INCOME FROM SALARY

1) He is working in a private company where the provident fund is recognized.

2) He is working in a private company where the provident fund is not recognized.
3) He is working in a Government organization.
Solution
1) Fund is recognized
TY 2010
Income from salary:
Basic salary (70,000 x 12) 840,000
Dearness allowance (10,000 x 12) 120,000
Rent allowance (30,000 x 12) 360,000

Employer’s contribution 126,000

Less: Exempt (lower of):
- 10% of (840,000 + 120,000) 96,000
- 150,000 150,000 (96,000) 30,000

Interest 40,000
Less: Exempt (higher of):
- 1/3rd of (840,000 + 120,000) 320,000
- 40,000/17% x 16% 37,647 (320,000) -
1,350,000
TY 2011
Income from salary:
Basic salary (80,000 x 12) 960,000
Dearness allowance (15,000 x 12) 180,000
Rent allowance (35,000 x 12) 420,000
Employer’s contribution 144,000
Less: Exempt (lower of):
- 10% of (960,000 + 180,000) 114,000
- 150,000 150,000 (114,000) 30,000

Interest 60,000
Less: Exempt (higher of):
- 1/3rd of (960,000 + 180,000) 380,000
- 60,000/17% x 16% 56,471 (380,000) -
1,590,000
TY 2012
Income from salary
Basic salary (90,000 x 9) 810,000
Dearness allowance (20,000 x 9) 180,000
Rent allowance (40,000 x 9) 360,000
Employer contribution 121,500
Less: Exempt (lower of):
- 10% of (810,000 + 180,000) 99,000
- 150,000 150,000 (99,000) 22,500

Interest 58,000
Less: Exempt (higher of):
- 1/3rd of (810,000 + 180,000) 330,000
- 58,000/17% x 16% 54,588 (330,000) -
Accumulated balance (exempt) -
1,372,500
2) Fund is not recognized
TY 2010
Income from salary:
Basic salary (70,000 x 12) 840,000
Dearness allowance (10,000 x 12) 120,000
Rent allowance (30,000 x 12) 360,000
1,320,000

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TY 2011
Income from salary:
Basic salary (80,000 x 12) 960,000
Dearness allowance (15,000 x 12) 180,000
Rent allowance (35,000 x 12) 420,000
1,560,000
TY 2012
Income from salary
Basic salary (90,000 x 9) 810,000
Dearness allowance (20,000 x 9) 180,000
Rent allowance (40,000 x 9) 360,000
Accumulated balance - Employer contribution 391,500
- Interest 158,000 549,500
1,899,500
3) Government employee
TY 2010
Income from salary:
Basic salary (70,000 x 12) 840,000
Dearness allowance (10,000 x 12) 120,000
Rent allowance (30,000 x 12) 360,000
1,320,000
TY 2011
Income from salary:
Basic salary (80,000 x 12) 960,000
Dearness allowance (15,000 x 12) 180,000
Rent allowance (35,000 x 12) 420,000
1,560,000
TY 2012
Income from salary
Basic salary (90,000 x 9) 810,000
Dearness allowance (20,000 x 9) 180,000
Rent allowance (40,000 x 9) 360,000
1,350,000

22