Is gratuity taxable when I retire from government or a private company?

What does the law say?

Section 12(2)(a) of the Income Tax Ordinance, 2001 lists gratuity as part of salary: “any pay, wages or other remuneration provided to an employee, including … gratuity”. Section 12(1) then taxes salary in the year it is received, “other than salary that is exempt from tax under this Ordinance”.

The exemption is clause (13) of Part I of the Second Schedule. It covers “any payment received by way of gratuity or commutation of pension by an employee on his retirement or, in the event of his death, by his heirs”, up to these limits:

Sub-clause	Who it covers	Exempt amount
(i)	Employee of the Government, a Local Government, or a statutory body or corporation established by law	The amount receivable under the rules and conditions of the employee’s service
(ii)	Anyone paid from a gratuity fund approved by the Commissioner under Part III of the Sixth Schedule	Any amount receivable from that fund
(iii)	Any other employee, under a scheme applicable to all employees of the employer and approved by the Board for this sub-clause	Up to Rs. 300,000
(iv)	Any employee to whom (i), (ii) and (iii) do not apply	50% of the amount receivable or Rs. 75,000, whichever is less

When is the exemption lost?

A proviso printed after sub-clause (iv) says “nothing in this sub-clause shall apply”:

• (a) to any payment which is not received in Pakistan;
• (b) to any payment received from a company by a director of such company who is not a regular employee;
• (c) to any payment received by an employee who is not a resident individual;
• and to any gratuity received by an employee who has already received any gratuity from the same or any other employer.

The last limb matters to people who retire twice, for example from the Army and later from a private company: the second gratuity may not get the exemption. The consolidated text prints the proviso directly after sub-clause (iv) and does not make clear whether “this sub-clause” also reaches sub-clauses (i) to (iii). This page does not settle that.

How does it work in practice?

Whatever part of the gratuity is not exempt is salary for the tax year you receive it. It is added to your other salary for that year and taxed on the salaried table in clause (2) of Division I, Part I of the First Schedule, which for tax year 2027 includes these bands:

Taxable income	Tax
Up to Rs. 600,000	0%
Rs. 600,001 to Rs. 1,200,000	1% of the amount over Rs. 600,000
Rs. 1,200,001 to Rs. 2,200,000	Rs. 6,000 + 11% of the amount over Rs. 1,200,000
Rs. 2,200,001 to Rs. 3,200,000	Rs. 116,000 + 20% of the amount over Rs. 2,200,000

Higher bands continue up to 35% above Rs. 7,000,000.

Worked example (illustrative figures)

Four people retire in tax year 2027, each receiving the same invented gratuity of Rs. 1,000,000 and each having earned Rs. 1,500,000 of ordinary salary earlier in the year. The rates are the real tax year 2027 rates.

Tax on the Rs. 1,500,000 salary alone: 6,000 + 11% of (1,500,000 - 1,200,000) = 6,000 + 33,000 = Rs. 39,000.

Retiree	Sub-clause	Exempt	Taxable gratuity
Rubina, Federal Government clerk	(i)	Rs. 1,000,000	Rs. 0
Asif, bank employee paid from an approved gratuity fund	(ii)	Rs. 1,000,000	Rs. 0
Zeeshan, pharmaceutical company with a Board-approved scheme	(iii)	Rs. 300,000	Rs. 700,000
Hina, small Sialkot export firm, no approved fund or scheme	(iv)	Rs. 75,000	Rs. 925,000

Zeeshan:

1. Total salary: 1,500,000 + 700,000 = 2,200,000
2. Band Rs. 1,200,001 to Rs. 2,200,000: 6,000 + 11% of 1,000,000 = 6,000 + 110,000 = Rs. 116,000
3. Extra tax because of the gratuity: 116,000 - 39,000 = Rs. 77,000

Hina:

1. Sub-clause (iv): 50% of 1,000,000 = 500,000. The lesser of Rs. 500,000 and Rs. 75,000 is Rs. 75,000.
2. Taxable gratuity: 1,000,000 - 75,000 = 925,000
3. Total salary: 1,500,000 + 925,000 = 2,425,000
4. Band Rs. 2,200,001 to Rs. 3,200,000: 116,000 + 20% of 225,000 = 116,000 + 45,000 = Rs. 161,000
5. Extra tax because of the gratuity: 161,000 - 39,000 = Rs. 122,000

Rubina and Asif pay only the Rs. 39,000 on their ordinary salary.

What if …?

The employee dies before retirement? Clause (13) applies to gratuity received “in the event of his death, by his heirs” on the same limits.

My employer’s fund is approved, but only by the Board for sub-clause (iii)? Sub-clause (ii) needs approval by the Commissioner under Part III of the Sixth Schedule. A Board-approved scheme under (iii) is a different thing and carries the Rs. 300,000 cap.

I also received commutation? Clause (13) covers “gratuity or commutation of pension”. Commutation from Government or a Board-approved pension scheme is separately exempt in full under clause (12).

Common mistakes

• Assuming all private gratuity is tax free. Only gratuity from an approved gratuity fund is fully exempt; otherwise the cap is Rs. 300,000 or Rs. 75,000.
• Taking 50% as the exempt amount. Sub-clause (iv) gives the lesser of 50% or Rs. 75,000, so for any gratuity above Rs. 150,000 the exemption is Rs. 75,000.
• Ignoring the second-gratuity rule. The proviso removes the exemption for an employee who has already received gratuity from the same or any other employer.

What to check in the official text

Read clause (13) of Part I of the Second Schedule with its proviso and footnotes (the Rs. 300,000 figure replaced “two” hundred thousand under the Finance Act, 2016). Part III of the Sixth Schedule sets the conditions for an approved gratuity fund. Which sub-clause an employer’s fund or scheme is approved under is a fact about that employer; the approvals themselves are not part of this corpus.