Why does my exempt share of profit from the AOP increase the tax on my salary or rent?

Your share of profit from a firm is exempt, but the Ordinance does not let it vanish from the picture. Section 88 of the Income Tax Ordinance, 2001 uses the exempt share to find the average rate you would pay if all your income were taxed together, and then applies that rate to your other income alone. The result is that rent, business income or salary is taxed at a higher rate than it would be on its own.

What does the law say?

Section 92(1) makes an association of persons (AOP) liable to tax separately from its members. Where the AOP has paid tax, the amount a member receives in that capacity out of the AOP’s income is exempt.

Section 88 then applies when, for a tax year, an individual has taxable income and also derives an amount exempt under section 92(1). The tax payable on the individual’s taxable income is computed with this formula, as printed in the official text:

(A/B) x C

Letter	Meaning in section 88
A	The tax that would be assessed to the individual for the year if the exempt amount under section 92(1) were chargeable to tax
B	The individual’s taxable income for the year if that exempt amount were chargeable to tax
C	The individual’s actual taxable income for the year

A divided by B is an average rate on the combined figure. Multiplying by C applies that average rate only to the income that is actually taxable.

How does it work in practice?

The partner works out tax twice in effect. First, on a notional income made up of the actual taxable income plus the exempt AOP share, using the slab table that applies to that individual. Second, that tax is scaled down to the actual taxable income.

Because the slab tables are progressive, the average rate on the larger notional income is higher than the average rate on the actual income alone. For tax year 2027 a non-salaried individual uses clause (1) of Division I of Part I of the First Schedule, which rises from 0% up to Rs. 600,000 to 45% above Rs. 5,600,000.

Rent counts here because section 15(1) makes rent chargeable under the head “Income from Property”, so it forms part of taxable income.

Worked example (illustrative figures)

Farhan is a partner in a textile trading firm in Faisalabad. For tax year 2027 his made-up figures are:

• Exempt share of profit from the firm, which has paid its tax: Rs. 3,600,000.
• Taxable income from renting out a shop: Rs. 2,400,000.
• No salary.

Step by step, using clause (1):

1. B = Rs. 2,400,000 + Rs. 3,600,000 = Rs. 6,000,000.
2. A = tax on Rs. 6,000,000. The band above Rs. 5,600,000 is Rs. 1,610,000 plus 45% of the excess. Excess: Rs. 400,000. 45% of Rs. 400,000 = Rs. 180,000. A = Rs. 1,610,000 + Rs. 180,000 = Rs. 1,790,000.
3. C = Rs. 2,400,000.
4. Tax = (1,790,000 / 6,000,000) x 2,400,000. Since 2,400,000 / 6,000,000 = 0.4, tax = 1,790,000 x 0.4 = Rs. 716,000.

For comparison, tax on Rs. 2,400,000 on its own under clause (1): the band from Rs. 1,600,000 to Rs. 3,200,000 is Rs. 170,000 plus 30% of the excess over Rs. 1,600,000. Excess: Rs. 800,000. 30% of that is Rs. 240,000. Tax: Rs. 410,000.

So the exempt share lifts Farhan’s tax on his rent from Rs. 410,000 to Rs. 716,000, an increase of Rs. 306,000. His Rs. 3,600,000 share itself is not taxed.

What if …?

What if my other income is a salary? Clause (2) of Division I applies different, lower rates where salary exceeds 75% of an individual’s taxable income. Section 88 does not say in so many words whether that 75% test, when working out A, is applied to taxable income with or without the exempt share. The text leaves this open, so the choice of table for A in a salaried case is not settled by the section itself.

What if I have no taxable income apart from the share? Section 88 applies only where the individual “has taxable income”. With C at nil, the formula gives nil tax.

What if the AOP’s share is not exempt? If the second proviso to section 92(1) removes the exemption (an AOP with turnover of Rs. 300 million or more that did not file audited financial statements), the share is not an amount exempt under section 92(1), and section 88 is not the route for it.

Common mistakes

• Adding the share to taxable income. The share is in A and B only. C is the actual taxable income.
• Ignoring the share because it is exempt. Section 88 is written precisely so the share counts towards the rate.
• Using a flat rate. A is computed on the full slab table, not by multiplying by the top rate.
• Assuming a company partner is covered. Section 88 speaks of “an individual”. A company member’s share is dealt with by the first proviso to section 92(1).

What to check in the official text

Read section 88 in the official PDF, where the formula line “(A/B) x C” is printed; the site text of the section loses that line in extraction. Read section 92(1) with its provisos. Check the slab tables in clauses (1) and (2) of Division I of Part I of the First Schedule, which the site text also drops.