How is a golden handshake or redundancy payment taxed when I am laid off?

A golden handshake is taxed as salary, but you do not have to accept the slab rate on it. The Income Tax Ordinance lets a departing employee choose a lower, averaged rate based on the tax they paid over the previous three years. Because a lump sum on top of a normal year’s pay usually lands in a high slab, the choice can make a large difference.

What does the law say?

Section 12(2)(e)(iii) includes in salary any amount received “on termination of employment, whether paid voluntarily or under an agreement, including any compensation for redundancy or loss of employment and golden handshake payments”. A voluntary separation scheme payment, a redundancy package or a negotiated exit payment all fall here. Section 12(1) taxes it in the tax year you receive it.

Section 12(6) gives the relief. An employee who received such an amount in a tax year “may, by notice in writing to the Commissioner, elect for the amount to be taxed” at the rate given by this formula:

A/B%

• A is the total tax paid or payable by the employee on total taxable income for the three preceding tax years.
• B is the employee’s total taxable income for those three years.

Section 12(8) sets the deadline: the due date for the employee’s return of income for the tax year in which the amount was received, or a later date the Commissioner allows. Section 118(3) makes that 30 September after the tax year ends. A payment received between 1 July 2026 and 30 June 2027 falls in tax year 2027, so the deadline is 30 September 2027 unless extended.

How does it work in practice?

When your employer pays the handshake, section 149 requires it to deduct tax at your average rate on your estimated salary for the year. The handshake is salary received in that year, and section 149 computes the deduction at the rates in Division I of Part I of the First Schedule. The section 12(6) election is made by you to the Commissioner. It is not an instruction to the employer, and the Ordinance does not say the employer can apply the A/B rate itself. Any tax deducted beyond the final liability is a credit under section 168 and refundable under section 168(5).

Section 12(6) says “the amount”, meaning the termination payment, is taxed at the A/B rate. The Ordinance does not separately spell out how the rest of that year’s salary is computed. The natural reading, used below, is that your ordinary salary for the year is still taxed on the slab table.

Worked example (illustrative figures)

Imran worked for a bank in Karachi and left under a voluntary separation scheme in tax year 2027. All income figures below are invented. The rates are the real tax year 2027 rates from clause (2) of Division I, Part I, First Schedule.

• Ordinary salary received in tax year 2027: Rs. 2,400,000
• Golden handshake received in tax year 2027: Rs. 3,000,000
• Taxable income, all salary, for tax years 2024, 2025 and 2026: Rs. 2,000,000, Rs. 2,200,000 and Rs. 2,300,000, total Rs. 6,500,000

The tax on those earlier years uses the salaried tables in force for each year, which the source PDF prints in the footnotes to clause (2):

Tax year	Taxable income (Rs.)	Band in that year’s table	Tax (Rs.)
2024	2,000,000	15,000 + 12.5% of amount over 1,200,000	115,000
2025	2,200,000	30,000 + 15% of amount over 1,200,000	180,000
2026	2,300,000	116,000 + 23% of amount over 2,200,000	139,000
Total	6,500,000		434,000

Without the election:

1. Total salary: 2,400,000 + 3,000,000 = 5,400,000
2. Band above Rs. 4,100,000 and up to Rs. 5,600,000: 541,000 + 29% of the amount above 4,100,000
3. 29% of 1,300,000 = 377,000
4. Tax: 541,000 + 377,000 = Rs. 918,000

With the section 12(6) election:

1. A/B = 434,000 / 6,500,000 = 6.68% (rounded)
2. Tax on the handshake: 3,000,000 x 434,000 / 6,500,000 = 200,308 (rounded to the rupee)
3. Tax on ordinary salary of Rs. 2,400,000: 116,000 + 20% of 200,000 = 156,000
4. Total: 200,308 + 156,000 = Rs. 356,308

On these figures the election reduces Imran’s tax year 2027 liability by Rs. 561,692 (918,000 minus 356,308). Without it, the handshake alone adds Rs. 762,000 (918,000 minus 156,000), an effective rate above 25% on the lump sum.

What if …?

I have not worked three full years? The formula uses “the three preceding tax years”. The Ordinance does not say how it applies if you had no taxable income in one or more of those years, and this page does not assume a result.

My average rate is higher than the slab rate would be? The election is optional. If A/B% gives more tax than the slab rate, there is no reason under the Ordinance to make the election.

The payment is spread over two tax years? Section 12(6) applies to an amount received “in a tax year”. Each year’s receipt would be considered for that year, and each has its own section 12(8) deadline.

Part of the payment is from my provident fund? Provident fund receipts are covered separately by section 12(2)(e)(iv) and by the exemptions in the Ordinance. They are not the same as termination compensation.

Common mistakes

• Thinking the handshake is tax free as compensation. Section 12(2)(e)(iii) expressly makes it salary.
• Waiting for the employer to apply the average rate. Section 12(6) requires the employee’s written notice to the Commissioner.
• Missing the deadline. After the section 12(8) date, only the Commissioner can allow a later election.
• Using only one year’s rate. A and B are totals over three preceding tax years, not the most recent year alone.

What to check in the official text

Read section 12(2)(e)(iii), 12(6) and 12(8) together, and section 118(3) for the return due date. A and B come from your own returns for the three preceding tax years, and the earlier years’ rate tables are in the footnotes to clause (2). Use the clause (2) table in Division I, Part I of the First Schedule for the tax on your ordinary salary for the year of receipt.