Is an interest-free or low-interest loan from my employer taxed as salary?

What does the law say?

Section 12(2)(b) of the Income Tax Ordinance, 2001 counts any perquisite as salary, and section 13 values particular perquisites. Three of its sub-sections deal with money between you and your employer.

Section 13(7): cheap loans. Where your employer lends you money on or after 1 July 2002, and you pay no profit or pay less than the benchmark rate, your salary for the year includes:

• (a) the profit on the loan computed at the benchmark rate, if you pay no profit; or
• (b) the difference between the profit you paid that year and the profit at the benchmark rate. (The consolidated text prints this limb as “(d)”.)

Two provisos limit this. The first says it does not apply to a benefit arising “due to waiver of interest by such employee on his account with the employer”. The second says it does not apply to “loans not exceeding one million rupees”.

Section 13(14): the benchmark rate. For the tax year starting 1 July 2002 (tax year 2003) it was five per cent, and for each later year one per cent higher than the year before, “but not exceeding ten per cent per annum”. Counting forward (2004: 6%, 2005: 7%, 2006: 8%, 2007: 9%, 2008: 10%), the formula hits the cap in tax year 2008 and stays at ten per cent after that, including tax year 2027.

Section 13(9): waived loans. If your employer waives an amount you owe it, the amount waived is added to your salary for that year.

Section 13(10): debts paid for you. If your employer pays an amount you owe to someone else, the amount paid is added to your salary for that year.

How does it work in practice?

Your employer adds the benchmark profit to your estimated salary and deducts tax on it through payroll under section 149, even though no cash reaches you. A waived loan or a debt paid on your behalf is added in the year the waiver or payment happens.

Situation	Added to salary
Loan of Rs. 1,000,000 or less, interest free	Nothing under section 13(7)
Loan above Rs. 1,000,000, interest free	Profit at 10% on the loan
Loan above Rs. 1,000,000 at a rate below 10%	10% profit minus the profit you paid
Loan at 10% or more	Nothing under section 13(7)
Employer writes off what you owe it	The amount written off (section 13(9))
Employer pays your bank, landlord or other creditor	The amount paid (section 13(10))

Worked example (illustrative figures)

Sana works for a bank in Faisalabad. Salary is her only income. For tax year 2027 (1 July 2026 to 30 June 2027) her salary is Rs. 2,400,000. On 1 July 2026 her employer gives her a Rs. 3,000,000 house-building loan at 4% a year, and the full amount is outstanding all year.

Step 1: profit at the benchmark rate. Rs. 3,000,000 x 10% = Rs. 300,000.

Step 2: profit she actually pays. Rs. 3,000,000 x 4% = Rs. 120,000.

Step 3: amount added to salary. Rs. 300,000 minus Rs. 120,000 = Rs. 180,000.

Step 4: taxable salary. Rs. 2,400,000 + Rs. 180,000 = Rs. 2,580,000.

Step 5: tax. Salary is more than 75% of taxable income, so clause (2) of Division I of Part I of the First Schedule applies. Between Rs. 2,200,000 and Rs. 3,200,000 the tax is Rs. 116,000 + 20% of the amount above Rs. 2,200,000:

Rs. 116,000 + 20% x Rs. 380,000 = Rs. 116,000 + Rs. 76,000 = Rs. 192,000.

Without the loan benefit, tax on Rs. 2,400,000 would be Rs. 116,000 + 20% x Rs. 200,000 = Rs. 156,000. The cheap loan adds Rs. 36,000 of tax for the year.

What if my loan is just over Rs. 1 million?

The proviso excludes loans “not exceeding one million rupees”. It does not say that only the part above Rs. 1 million is counted once a loan crosses the limit. On the words of section 13(7), the benchmark profit is computed on “the loan”, but the text does not spell out how a partly repaid loan or a loan that falls below Rs. 1 million during the year is measured. Where that matters, the Ordinance text we hold leaves the point open.

What if I used the loan to buy property that earns income?

Section 13(8) says that, for purposes of the Ordinance other than section 13(7), where you use such a loan to acquire an asset or property that produces taxable income, you are treated as having paid profit at the benchmark rate on the loan, or on the part used for that asset. Whether that treated profit is deductible depends on the rules for that other head of income, which this page does not cover.

Common mistakes

• Assuming every staff loan is taxable. Loans not exceeding Rs. 1 million are outside section 13(7).
• Using the State Bank policy rate. The benchmark in section 13(14) is its own formula, capped at ten per cent. The State Bank discount rate was the pre-2002 definition, since replaced.
• Forgetting the write-off. When an employer forgives a salary advance, section 13(9) taxes the waived amount as salary.
• Treating employer-paid personal bills as gifts. Section 13(10) adds any debt of yours that the employer pays.

What to check in the official text

• Section 13(7), (8), (9), (10) and (14) in the official PDF, including the lettering of the limbs of section 13(7).
• The loan agreement: the amount, the profit rate and dates of disbursement and repayment, because section 13(7) is computed for each tax year.