Exemptions & Taxable Income

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Exemptions & Taxable Income — Key ACCA/CA Pakistan Facts

Two Main Sources of Exemptions in Pakistan:

1. First Schedule (ITO 2001) — Exemptions from specific heads of income
2. Part X (Sections 60–63) — Deductions from gross income to arrive at taxable income

First Schedule Exemptions (selected):

• Agricultural income (Section 41) — Exempt from income tax (but relevant for determining tax liability under the partial rebate mechanism)
• One residential house (individual, used for personal residence) — Exempt from property income
• Interest on savings deposits — Exempt up to PKR 240,000 per annum (for individuals only) under certain conditions
• Dividend income — Exempt up to PKR 150,000 per annum for individuals
• Retirement gratuity from approved fund — Exempt
• Proceeds of life insurance policies — Exempt (subject to conditions)
• Scholarships — Exempt if received for education in Pakistan

Part X Deductions:

• Section 60C: Charitable donations (to approved institutions) — up to 30% of gross income
• Section 60D: Investment in health insurance — up to PKR 100,000 per annum
• Section 60E: Retirement contributions (annuity/insurance for retirement) — up to PKR 500,000 per annum
• Section 60F: Profits on debt — deductions for certain savings instruments

Taxable Income = Gross Income − Exemptions − Deductions under Part X − Losses Set Off

⚡ Exam Tip: Always identify exempt income before computing taxable income. Exempt income is excluded from gross income entirely — it does not merely reduce the tax rate.

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Exemptions & Taxable Income — ACCA/CA Pakistan Study Guide

1. First Schedule — Exemptions in Detail

The First Schedule provides a comprehensive list of exemptions. The key principle is: exempt income is not included in gross income at all. It is excluded from all calculations upstream.

Categories of Exemptions:

A. Agricultural Income (Section 41): Agricultural income is exempt from income tax. However, there is a partial rebate mechanism — if a person has both agricultural income (exempt) and income from other sources (taxable), the tax on non-agricultural income is computed as if the agricultural income were added to it, and then the tax on the agricultural portion is rebated. This prevents a higher effective tax rate on the non-agricultural income merely because of the existence of agricultural income.

B. Interest Income Exemptions (First Schedule):

• Savings bank accounts: Interest exempt up to PKR 240,000 per annum (if account is maintained in a scheduled bank and the depositor is an individual)
• Specific savings instruments: e.g., National Savings Schemes, Special Savings Bonds — interest/exchange profit may be exempt or taxed at reduced rates
• Government bonds: Certain prize bonds and bonds are exempt from tax

C. Dividend Income Exemption (First Schedule):

• Cash dividend: Exempt up to PKR 150,000 per annum for individuals
• Stock dividend (bonus shares): Not treated as income at the time of receipt; the cost of acquisition is the disposal cost basis of the original shares

D. Property Income Exemptions:

• One residential house used for personal residence — exempt under the First Schedule
• Exception: If the house is also partly used for business, the exemption is restricted to the portion used for residence

E. Employment/Salary Exemptions:

• Transport allowance for certain government employees (PKR 18,000/year)
• Free transport for business travel (not personal use)
• Medical treatment in Pakistan by employer’s panel doctor
• Retirement gratuity from an approved gratuity fund

F. Other Exemptions:

• Amounts received as compensation for wrongful dismissal or accident (subject to limits)
• Prizes/awards for academic, scientific, or sporting achievements — exempt
• Alimony received — exempt
• Leave encashment for government employees — exempt

2. Part X — Deductions (Sections 60–63)

These deductions are subtracted from gross income to arrive at taxable income.

Section 60C — Charitable Donations:

• Donations to approved charitable institutions (registered under the Income Tax Ordinance) are deductible
• Maximum deduction: 30% of the gross income of the taxpayer
• Conditions:
  • The institution must be approved by the Commissioner
  • The donation must be notional or actual — evidenced by a proper receipt
  • Cannot be a donation to a related party unless specifically allowed

Section 60D — Health Insurance Premium:

• Premium paid on health insurance policy for the taxpayer, spouse, or children
• Maximum deduction: PKR 100,000 per annum
• Conditions: Policy must be with an Insurance Company registered in Pakistan

Section 60E — Retirement Contributions:

• Contributions to:
  • Approved pension fund
  • Approved annuity plan
  • Life insurance with a saving element (limited)
• Maximum deduction: PKR 500,000 per annum
• Note: Contributions to the ** employee’s own provident fund** (if approved) are separately deductible under Section 60

Section 60F — Profits on Debt:

• Profits on certain government savings instruments and bonds
• Available for individuals only
• Specific instruments listed in the Schedule (e.g., National Savings, Special Savings)

3. Set Off of Losses (Section 41A)

Losses can be set off against income from the same head in the same tax year (current year losses). If losses cannot be fully absorbed, they can be carried forward for set off against income from the same head in subsequent years.

Rules for Loss Set Off:

Loss Type	Can be set off against	Carried Forward
Business loss (Section 16)	Business income (same head)	6 years
Property loss (Section 16)	Property income (same head)	6 years
Capital loss (Section 37)	Capital gains (same type only)	6 years
Loss from other sources	Other source income (same head)	6 years

⚡ Key Restriction: Losses from salary income cannot be set off against any other head — salary is never a loss.

Losses from a Partnership:

• A partner cannot claim the partnership’s losses personally — losses belong to the partnership and are allocated to partners in the profit-sharing ratio
• Partner’s share of loss is added to their personal income and can be set off against their other income (subject to the same head rules)

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Exemptions & Taxable Income — Comprehensive ACCA/CA Pakistan Notes

1. Conceptual Framework — Gross Income vs. Taxable Income

The computation of taxable income follows a clear hierarchical structure:

Gross Income (all 5 heads)
  ↓
Less: Exempt Income (First Schedule and other provisions)
  ↓
Net Income (taxable base)
  ↓
Less: Deductions under Part X (donations, retirement contributions, etc.)
  ↓
Less: Set off of current year losses
  ↓
Less: Brought forward losses from prior years (set off subject to limits)
  ↓
Taxable Income
  ↓
Apply: Tax Rates (slabs for individuals/AOPs; flat rate for companies)
  ↓
Tax Liability
  ↓
Less: Tax Credits (foreign tax credit, PAYE, etc.)
  ↓
Net Tax Payable / (Refundable)

2. Comprehensive First Schedule Exemptions

Part I — Exemptions from Salary (selected):

• Free or subsidized transport provided for business travel: Exempt
• Medical facilities in Pakistan by employer’s panel: Exempt
• Contribution to approved pension fund by employer: Exempt (subject to limits)
• Gratuity from approved fund: Exempt
• Interest on accumulated PF balance (up to 12%): Exempt

Part II — Exemptions from Property Income:

• One residential house (self-occupied): Exempt
• Property used for charitable purposes: Exempt
• Agricultural income from land: Exempt

Part III — Exemptions from Business Income:

• Income of small companies from certain zones (export-oriented industries in Special Economic Zones): Tax holiday for specified periods
• Cooperative societies — limited exemptions

Part IV — Exemptions from Capital Gains:

• Transfer of property between spouses/parents/children (but subsequent disposal by the recipient will attract tax)
• Disposal by way of bequest or inheritance
• One residential house (under specific conditions — see below)

Part V — Exemptions from Income from Other Sources:

• Dividends up to PKR 150,000 (individuals)
• Interest on savings deposits up to PKR 240,000 (individuals)
• Prizes from savings: Certain National Savings prizes (lottery element exempt)

3. One Residential House Exemption — Detailed Conditions

The exemption for one residential house (under Section 41 and First Schedule) is one of the most tested exemptions. The conditions are cumulative:

1. The person must be an individual (not a company, AOP, or firm)
2. The house must be one residential house only — the individual must not own any other residential property anywhere in Pakistan
3. The house must be used for the personal residence of the individual (or his family — spouse, minor children)
4. The total income of the individual must not exceed PKR 5 million per annum
5. The exemption applies to capital gains arising from the disposal of such a house

⚡ Common Mistake: Students treat the one-house exemption as automatic. It is not — the conditions are strict and the burden of proof is on the taxpayer to demonstrate compliance with all conditions.

4. Agricultural Income — Partial Rebate Mechanism

This is a complex area that frequently appears in exams. The partial rebate ensures that agricultural income does not push the taxpayer into a higher tax bracket for non-agricultural income.

Mechanism:

Step 1: Compute tax on (Non-Agricultural Income + Agricultural Income) 
        using the normal slab rates
Step 2: Compute tax on (Non-Agricultural Income) alone using the slabs
Step 3: Rebate = Tax at Step 1 − Tax at Step 2
Step 4: Net tax = Tax at Step 1 − Rebate

Example:

Non-Agricultural Income: PKR 3,000,000
Agricultural Income (Exempt): PKR 2,000,000
Total income for rate purposes: PKR 5,000,000

Tax on PKR 5,000,000: 
  First 600,000 @ 0% = 0
  600,001 - 1,200,000 @ 12.5% = 75,000
  1,200,001 - 2,400,000 @ 15% = 180,000
  2,400,001 - 3,600,000 @ 20% = 240,000
  3,600,001 - 5,000,000 @ 25% = 350,000
  Total = 845,000

Tax on PKR 3,000,000 (non-agricultural only):
  First 600,000 @ 0% = 0
  600,001 - 1,200,000 @ 12.5% = 75,000
  1,200,001 - 2,400,000 @ 15% = 180,000
  2,400,001 - 3,000,000 @ 20% = 120,000
  Total = 375,000

Rebate = 845,000 - 375,000 = 470,000
Net tax = 845,000 - 470,000 = 375,000

⚡ Key Point: The rebate is available only to individuals — companies and AOPs cannot claim agricultural income rebate.

5. Part X Deductions — Detailed Analysis

Section 60C — Charitable Donations (30% of Gross Income):

• The institution must be on the approved list maintained by the FBR
• Donation must be supported by a donation receipt certificate from the institution
• If total donations exceed 30% of gross income in a year, the excess can be carried forward for 3 years
• Donations to educational institutions and hospitals operated by the government or a non-profit are generally approved

Section 60D — Health Insurance Premium:

• Applies to medical insurance policy (not life insurance)
• Must be with an insurance company registered in Pakistan
• Covers the taxpayer, spouse, children, or parents (if dependent)
• Maximum deduction: PKR 100,000 per annum (aggregate)
• This is in addition to any employer-provided health coverage

Section 60E — Retirement Contributions: This is one of the most important deductions for tax planning. The maximum aggregate deduction is PKR 500,000 per annum. This includes:

• Contributions to approved pension fund
• Contributions to approved annuity plan
• Premiums for life insurance with a saving element (not pure term insurance)
• Contributions to employees’ provident fund (employer + employee)

Section 60F — Profits on Debt (Savings Instruments): Profits from the following are deductible (reducing taxable income):

• National Savings Schemes (certain types)
• Special Savings Bonds
• Defense Savings Certificates
• Bahria Currency

⚡ Common Mistake: Students confuse the tax credit for retirement contributions (Section 60E deduction from income) with the tax credit under Section 61 (tax withheld and paid). Section 60E reduces the taxable income — the actual deduction. Section 61 gives a credit for taxes already paid.

6. Comprehensive Tax Computation Exercise

Example — Individual Tax Computation:

Income from Salary (Gross):              PKR 3,500,000
Less: Exempt allowances:                    (150,000)
Taxable Salary:                           PKR 3,350,000

Income from Business:                      PKR 2,000,000
Less: Business deductions:                  (400,000)
Taxable Business Income:                  PKR 1,600,000

Agricultural Income (Exempt):               PKR 1,500,000
Capital Gains (Long-term, listed shares):  PKR 500,000

Total Gross Income:                        PKR 5,950,000
Less: Exempt Agricultural Income:          (1,500,000)
Net Income:                                PKR 4,450,000

Less: Section 60C Donation (PKR 150,000 approved, max 30% of 4,450,000 = 1,335,000 → 150,000 allowed)
                                                    (150,000)
Less: Section 60E Retirement contribution:  (200,000)

Taxable Income:                            PKR 4,100,000

[Then compute tax using slabs and apply agricultural rebate]

⚡ Exam Tip: Always compute agricultural income rebate at the end. The rebate is the difference between tax computed on (taxable income + exempt agricultural income) and tax computed on (taxable income alone).

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