Over the past few years, the salary taxation scene has changed radically. Salaries in the private sector have touched new highs. The annual salary income of a bank president averages Rs40 million a year and a new salaried class of high net worth individuals is coming up.

Responding to the changing situation, the Federal Board of Revenue (FBR) raised its taxation slab two years ago. The salary income slab now cascades between the lowest salary income exceeding Rs150, 000 (Rs.200, 000 for women), imposing tax at the rate of 0.25 per cent and highest annual salary income at Rs8.4 million with a tax at the rate of 20 per cent on taxable salary net of any Zakat paid.

The business income slab recognises the lowest taxable income exceeding Rs100,000 (125,0000 for women) and imposes tax at 0.50 per cent and highest annual taxable income at Rs1.3 million and imposes tax at 25 per cent net of any Zakat and deductible allowances. For the first time, the highest salary income bracket has far outpaced the highest business income bracket by almost 700 per cent, a fundamental change in the taxation policy over the past 60 years. A new fashion of hiring employees as pioneered by the banking and a host of other service sector companies is recruitment on “contract” basis. Most of these employees barely fetch an average gross salary ranging between Rs100,000--300,00 and are being subjected to a flat rate of tax deduction of 10 per cent whereas according to the salary slab, their tax incidence ranges between 0.50-7.5 per cent. How far this rate of deduction is a fair is a debatable issue.

These employees are unable to safeguard their rights as taxpayers because most of them have never filed returns or they lack proper information. On the face of it, such contract employees face harsh tax burden. The tax fate of the potential 25000 employees/optees of the voluntary retirement scheme (VRS) offered by the PTCL also hangs in balance in terms of bearing true tax incidence.

The Income Tax Law contemplates two treatments for salary income: (i) taxable salary income and (ii) exempt salary income as provided in the separate Schedule to the Tax Law of 2001. Salary income is taxed only when it is received by an employee from an employer. It means that the master-servant relationship underlies the scheme. The Income Tax Law contemplates seven shades (cash and non-cash) of salary income. Of these; five shades of salary income are necessarily cash modes and two shades are necessarily non-cash modes and together cover the most popular ways of remunerating employees, in Pakistan or globally.

Five cash modes of salary income are recognised as (i) pay/wages, (ii) allowances, (iii) excess reimbursement of expenditure, (iv) any bulk/ lump sum payment/ capital receipts affecting the employment terms of an employee including golden hand shake (VSS) payments and are in some cases exempt subject to fulfillment of a set of conditions (v) pension/ annuity/ or its supplements, and two no-cash modes of salary income recognised as (i) perquisites and (ii) compensation in stocks (shares) and options.

The salary mix in the nature of payment/wages is of ten sub-categories and understood in the commercial world as; (i) pay, (ii) wages, (iii) other remuneration provided to an employee, (iv) leave pay. (v) payment in lieu of leave, (vi) overtime payment ,(vii) bonus (viii) commission, (ix) fees, (x) gratuity and, (xi) special wages paid against dangerous or unpleasant work--a deep sea diver, a fire-fighter or a soldier posted at Siachen.

The salary mix in the nature of allowances is of seven sub-categories as are commercially recognised in the community of employers: (i) cost of living allowance (ii) subsistence allowance (iii) rent allowance (iv) utilities allowance, (v) education allowance (vi) entertainment allowance and (vii) travel allowance. The most critical feature of taxation of allowances is that any special allowance which is “solely expended in the performance of the employees’ duties of employment” is not taxable. This provision has sufficient scope of tax planning while structuring the salary transactions and remains by and large an untapped avenue by most of the employers/employees including banking companies and other MNCs operating in Pakistan.

Risk areas: The risk areas in salary taxation demanding highest vigilance by both employers and employees is the principle by which every type of privilege provided to an employee is taxed as money equivalent whether provided directly or through an associate or through a third party.

The salary mix of such privileges expressly stated as “ perquisites” and provided by the employer are of 10 types enumerated as: (i) valuation of motor vehicle(conveyance), (ii) any servant i.e. housekeeper, driver, gardener or other domestic servant provided to the employee, (iii) any utility (electricity, gas, water and telephone) provided, (iv) any interest ‘free’ or ‘discounted’ interest rate loan provided. (v) any loan waived by an employer that he owed to an employee, (vi) any loan paid by an employer that an employee owed to a third party, (vii) any property of an employer transferred to an employee without consideration, (viii) any service (facility of any type) provided free of charge, (ix) any accommodation or a house and, (x) any other type of privilege or perquisite provided to an employee..

An equally risky area to be appreciated by both employers and employees is the principle that where any shares or stocks are issued to an employee by an employer company, the market value of those shares at the time of issuance is also treated as a salary income. The Income Tax Law, however, contemplates an exemption on the value of any right or option to acquire share or stock granted to an employee under an “employee share scheme.”

It is on record that the FBR had collected hundreds of millions of rupees in default of payroll taxes from the employees of MNCs in 1999 for not offering the stocks and options issued to them. A salaried employee must register that the perquisites, stocks and options paid in non-cash modes are taxed by converting them into cash equivalent on the principles of (a) actuality of cost or (b) their market valuation.

Principles of taxation: The taxation of salary income is governed by an elaborated set of principles: (i) salary income can be taxed when it is actually received by an employee, (ii) no deduction is admissible against salary income for any expenditure incurred for deriving it, (iii) any amount received by or any perquisite provided to an employee directly or indirectly, is covered under salary income, (iv) any tax due on the salary of an employee is included as salary income even when paid by an employee.

Concessions and exemptions: An employee has a lawful right to pay tax on his choice at a lower rate on receipt of payment in the nature of or VSS/golden hand shake. Similarly; an employee has a lawful right to pay tax at his choice at a lower rate on receipt of any capital receipt in nexus with the salary income or by way of arrears. .In order to exercise the right of incidence of tax at lower rate; an employee is obliged to notify the commissioner of Income Tax about his choice.

The applicant must serve such notice before the expiry of the due date of furnishing of return for every tax year which is on or before September 30, each tax year .The delay if any, in serving such notice after the this date is condonable by the commissioner on case- to-case basis.

After having understood the basic framework of salary taxation, the next step could be to identify opportunities of tax savings that is provided within the law.