A controversial proposal within the Finance Bill 2025-26 to tax pension income exceeding Rs10 million annually at a rate of 5% has sparked widespread concern and criticism among pensioners and tax experts alike. Critics argue that the proposed changes, if approved by Parliament, could inadvertently lead to a higher tax burden for a broad spectrum of pensioners, including those with significantly lower annual incomes, and effectively render commutation taxable, as reported by The News on Saturday.
The element of commutation requires thorough review in the proposed changes to the law because every officer of higher grades who receives the maximum limit in advance will face increased tax amounts. Dr. Muhammad Iqbal, former member of Federal Board of Revenue (FBR) Policy, voiced strong reservations, stating, “FBR ostensibly made changes in the tax regime applicable to pensions to tax pension income exceeding Rs10 million in a year, but ended up taxing the income of most of the pensioners drawing far less amount of annual pension at much higher rates.”
At the heart of the debate is the proposed omission of Clause 12 of Part I of the second schedule to the Income Tax Ordinance. As a result, pension income, which has always been treated as part of salary income due to the definition of salary income provided in section 12 of the Ordinance, would become taxable at the rates applicable to salary income.
All the FBR was required to do was to treat pension as a separate block instead of subjecting it to the rates applicable to salary income. It attempted to do this by proposing to add a proviso at the end of Table II in Division I of Part I of the First Schedule. This Table provides the tax rates applicable to various income slabs, ranging from 1% (which was now proposed to increase from 1% to 2.5% in the cabinet) to a maximum of 35%. The slab rate of 35% is applicable on annual salary income of Rs4.1 million.
The proviso proposed to be inserted through the Finance Bill reads as: “Provided that in the case of an individual deriving income solely from pension, annuity, supplement to the pension or annuity and commutation of pension from former employer for tax year, the rate of tax on such annuity or pension income or commutation of pension shall be set out in the following table:”
The subsequent table provides a flat rate of 5% on pension income exceeding Rs10 million per year. What the drafters of this proviso did not realize was that the word “solely” used in the proviso makes it inapplicable to all pensioners who have a source of income other than a pension. Currently, almost all pensioners have other sources of income, most commonly interest or profits from amounts held in profit and loss accounts maintained in banks or savings schemes.
