Are pension arrears or a lump sum of back pension taxed at a higher rate?

What does the law say?

Pension is salary. Section 12(2)(f) of the Income Tax Ordinance, 2001 includes “any pension or annuity, or any supplement to a pension or annuity” in salary, and section 12(1) charges salary “received by an employee in a tax year” in that year. Arrears are therefore counted in the year they are received, not the year they relate to.

Section 12(7) provides relief. Where any amount chargeable under the head “Salary” is paid in arrears, and as a result the employee is chargeable at higher rates than if it had been paid in the year the services were rendered, the employee may, by notice in writing to the Commissioner, elect for the amount to be taxed at the rates that would have applied in that earlier year.

Section 12(8) sets the time limit: the election must be made by the due date for furnishing the return of income or employer certificate for the tax year in which the amount was received, or by a later date the Commissioner allows.

How do arrears interact with the pension table?

For tax year 2027 the pension table in the proviso to clause (2) of Division I of Part I of the First Schedule reads:

Pension received in the tax year	Rate of tax
Does not exceed ten million rupees	0% of the amount
Exceeds ten million rupees	5% of the amount exceeding ten million rupees

The table speaks of pension “received … in a tax year”. Section 149(1A) likewise tells the payer to deduct tax only where the payment during the tax year exceeds ten million rupees, and only on the part above that figure. So arrears only change the answer for someone whose pension plus arrears in one year crosses ten million rupees. A pensioner aged seventy or more is not charged on pension income at all under section 12(2A)(i).

Worked example (illustrative figures)

Case 1: pension table. Brig. (retd) Hamid, 66, Rawalpindi, receives Rs. 9,500,000 of pension in tax year 2027. After a revision he also receives Rs. 1,000,000 of arrears for tax year 2026, when his pension had been Rs. 8,000,000.

1. Pension received in tax year 2027: Rs. 9,500,000 + Rs. 1,000,000 = Rs. 10,500,000.
2. Amount above ten million: Rs. 10,500,000 - Rs. 10,000,000 = Rs. 500,000.
3. Tax at 5%: Rs. 500,000 x 5% = Rs. 25,000.
4. Had the arrears been paid in tax year 2026, that year’s pension would have been Rs. 9,000,000, below ten million rupees.

This is the situation section 12(7) is written for. Whether the election can be applied to a pension charged as a final tax under section 12(2A), and treat tax year 2026 as the year “the services were rendered”, is not stated in the text.

Case 2: re-employed pensioner on slab rates. Mrs. Qureshi, 62, Lahore, still works part-time for her former employer, so section 12(2A)(ii) taxes her pension at the ordinary salary rates. Her salary and pension for tax year 2027 are Rs. 2,000,000, and she receives Rs. 1,000,000 of pension arrears relating to tax year 2026, when her income was also Rs. 2,000,000.

Tax year 2027 salary table (clause (2) of Division I):

1. Without arrears: Rs. 2,000,000 is in the row Rs. 1,200,000 to Rs. 2,200,000. Tax = Rs. 6,000 + 11% of Rs. 800,000 = Rs. 6,000 + Rs. 88,000 = Rs. 94,000.
2. With arrears: Rs. 3,000,000 is in the row Rs. 2,200,000 to Rs. 3,200,000. Tax = Rs. 116,000 + 20% of Rs. 800,000 = Rs. 116,000 + Rs. 160,000 = Rs. 276,000.
3. Tax caused by the arrears in tax year 2027: Rs. 276,000 - Rs. 94,000 = Rs. 182,000.

Tax year 2026 salary table (the table the Finance Act 2026 replaced, quoted in the footnote):

4. Rs. 2,000,000: Rs. 6,000 + 11% of Rs. 800,000 = Rs. 94,000.
5. Rs. 3,000,000: Rs. 116,000 + 23% of Rs. 800,000 = Rs. 116,000 + Rs. 184,000 = Rs. 300,000.
6. Tax the arrears would have caused in tax year 2026: Rs. 300,000 - Rs. 94,000 = Rs. 206,000.

Here receiving the arrears later did not put her at higher rates, because the tax year 2027 table is lighter in that band. Condition (b) of section 12(7) asks whether the employee is chargeable at higher rates as a result of late payment, so on these figures the election would not help.

What if the arrears relate to a year when pension was exempt?

Until the Finance Act 2025, clause (8) of Part I of the Second Schedule exempted “any pension received by a citizen of Pakistan from a former employer”, with exceptions. The footnote records its omission. Arrears for tax year 2025 or earlier that are received in tax year 2027 are still received in tax year 2027. Section 12(7) asks what rates would have applied in the year the services were rendered, but it does not say how an exemption that existed in that year is treated. This page does not resolve that.

Common mistakes

• Assuming there is an “arrears rate”. There is none. Arrears are added to the year of receipt.
• Missing the deadline. The section 12(8) election is due by the return or employer certificate due date for the year of receipt, unless the Commissioner allows more time.
• Electing without comparing. Section 12(7) is available only where late payment causes higher rates. The tables changed between tax years 2026 and 2027, so the answer depends on the figures.

What to check in the official text

Read section 12(1), (2)(f), (2A), (7) and (8), and section 149(1A). Read the pension proviso and the clause (2) salary table in Division I of Part I of the First Schedule in the official PDF, including the footnote quoting the tax year 2026 table, since our site copy leaves out rate tables. The form of the notice to the Commissioner is not prescribed in the text we hold.