A contentious proposal within the Finance Bill 2025-26 to impose a 5% tax on annual pension income exceeding Rs10 million has ignited widespread concern and criticism among pensioners and tax experts.
Critics contend that the proposed legislative changes, if enacted by Parliament, could inadvertently lead to a higher tax burden for a broad range of pensioners, including those with significantly lower annual incomes, and effectively render commutation taxable, The News reported on Saturday.
The element of commutation necessitates a thorough review within the proposed amendments to the law, as every higher-grade officer receiving the maximum advance limit will face increased tax liabilities.
Dr. Muhammad Iqbal, former member of Federal Bureau of Revenue (FBR) Policy, expressed 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 core of the debate is the proposed removal of Clause 12 of Part I of the second schedule to the Income Tax Ordinance.
Consequently, pension income, which has consistently been categorized as part of salary income due to the definition provided in section 12 of the Ordinance, and taxed at rates applicable to salary income, would be affected.
All that the FBR was required to do was to treat pension as a separate block of income rather than subjecting it to the salary income tax rates.
The FBR attempted to achieve 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 outlines the tax rates applicable to various income slabs, currently ranging from 1% (proposed to increase from 1% to 2.5% in the cabinet) up to a maximum of 35%.
The 35% slab rate is currently applicable to an annual salary income of Rs4.1 million.
The proviso proposed for insertion through the Finance Bill states: “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 specifies a flat rate of 5% on pension income exceeding Rs10 million annually. However, the drafters of this proviso apparently overlooked that the word “solely” renders it inapplicable to nearly all pensioners who possess income sources beyond just their pension.
Presently, almost all pensioners have other sources of income, most commonly interest or profits derived from funds held in profit and loss accounts maintained in banks or through various savings schemes.
