Is a golden handshake or early retirement package taxable, and can it be taxed at a lower average rate?

What does the law say?

A golden handshake is salary. Section 12(2) of the Income Tax Ordinance, 2001 defines salary as “any amount received by an employee from any employment, whether of a revenue or capital nature”. Clause (e) of that sub-section then lists profits in lieu of or in addition to salary, and sub-clause (iii) covers 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”.

Section 12(1) charges salary to tax in the tax year it is received. Without an election, the golden handshake is added to the rest of the year’s salary and taxed on the salaried table in clause (2) of Division I of Part I of the First Schedule.

Section 12(6) offers an alternative. An employee who has received an amount under section 12(2)(e)(iii) in a tax year “may, by notice in writing to the Commissioner, elect for the amount to be taxed at the rate computed in accordance with the following formula”: A/B%, where

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

Section 12(8) sets the time limit. The election “shall be made by the due date for furnishing the employee’s return of income or employer certificate, as the case may be, for the tax year in which the amount was received or by such later date as the Commissioner may allow”.

Why does the election matter?

The salaried table is progressive. For tax year 2027 (1 July 2026 to 30 June 2027) it runs from 0% on income up to Rs. 600,000 to Rs. 1,424,000 plus 35% of the amount above Rs. 7,000,000. A large one-off payment can push a whole year’s income into the top band. The A/B% rate is based on what you actually paid in the three years before, which can be much lower than the top band a lump sum reaches.

Worked example (illustrative figures)

Imran leaves a bank in Lahore under a voluntary separation scheme in tax year 2027. He receives Rs. 1,800,000 of ordinary salary during the year and a golden handshake of Rs. 6,000,000. Over the three preceding tax years his total taxable income was Rs. 7,500,000 and the total tax on it was Rs. 450,000. All amounts are invented; the table is the real tax year 2027 salaried table.

Without the election

1. Total salary: 1,800,000 + 6,000,000 = Rs. 7,800,000
2. Band above Rs. 7,000,000: 1,424,000 + 35% of (7,800,000 - 7,000,000)
3. 35% of 800,000 = 280,000
4. Tax: 1,424,000 + 280,000 = Rs. 1,704,000

With the section 12(6) election

1. A/B% = 450,000 / 7,500,000 = 6%
2. Tax on the golden handshake: 6,000,000 x 6% = Rs. 360,000
3. Tax on the ordinary salary of Rs. 1,800,000: 6,000 + 11% of (1,800,000 - 1,200,000) = 6,000 + 66,000 = Rs. 72,000
4. Total: 360,000 + 72,000 = Rs. 432,000

In this illustration the election lowers the tax by 1,704,000 - 432,000 = Rs. 1,272,000.

Section 12(6) sets the rate for “the amount” received under section 12(2)(e)(iii). It does not spell out the rest of the computation, so step 3 reflects a reading in which the remaining salary is taxed on the normal table on its own. The section does not state this in so many words.

Which parts of a retirement package qualify?

Only the termination payment falls within section 12(2)(e)(iii). A package often bundles several items, and the Ordinance places them in different clauses:

Item	Where the Ordinance places it	Average-rate election?
Golden handshake, redundancy or loss-of-employment compensation	Section 12(2)(e)(iii)	Yes, section 12(6)
Gratuity	Section 12(2)(a), with exemptions in clause (13) of Part I of the Second Schedule	Not mentioned in section 12(6)
Leave pay or payment in lieu of leave	Section 12(2)(a)	Not mentioned in section 12(6)
Amount from a provident or other fund	Section 12(2)(e)(iv)	Not mentioned in section 12(6)
Pension	Section 12(2)(f) and section 12(2A)	Not mentioned in section 12(6)

Gratuity is the item most often confused with a golden handshake. Section 12(2)(a) names “gratuity” among pay and remuneration, so it sits under clause (a), not (e)(iii). Clause (13) of Part I of the Second Schedule gives it separate exemption limits instead.

What if …?

The payment is made in arrears for earlier service? Section 12(7) is a different election: salary paid in arrears can be taxed at the rates that would have applied in the year the services were rendered. It is also subject to the section 12(8) deadline.

You had no taxable income in the three preceding years? Section 12(6) defines A and B but does not say what happens when B is zero. The Ordinance is silent on that case.

The deadline has passed? Section 12(8) allows the election “by such later date as the Commissioner may allow”. It does not set conditions for that extension.

Common mistakes

• Treating the golden handshake as tax-free capital. Section 12(2) covers amounts “of a revenue or capital nature”, and (e)(iii) names golden handshake payments.
• Applying the average rate to gratuity or leave pay. Section 12(6) refers only to sub-clause (iii) of clause (e).
• Missing the notice. The election is made by written notice to the Commissioner within the section 12(8) time limit. Without it, the normal table applies.

What to check in the official text

Read section 12(1), (2), (6), (7) and (8) of the Income Tax Ordinance, 2001 as amended to 30 June 2026, and the salaried table in clause (2) of Division I of Part I of the First Schedule for tax year 2027. Clause (13) of Part I of the Second Schedule covers gratuity. How the employer deducts tax on the payment, and the form of the notice, are not set out in section 12, and FBR forms are not part of this corpus.