Is medical allowance tax free, and what about medical bills my company reimburses?

What does the law say?

Section 12 of the Income Tax Ordinance, 2001 treats almost everything an employer gives you as salary, including allowances (section 12(2)(c)) and any of your own expenses that the employer pays or reimburses (section 12(2)(d)). Medical benefits are pulled back out of that net by clause (139) of Part I of the Second Schedule, which lists them as exempt. Clause (139) has two parts, and they work very differently.

Part one: free treatment or reimbursed bills. The benefit of free medical treatment or hospitalisation provided by the employer, or the reimbursement you receive for medical or hospital charges you paid, is exempt where it is “in accordance with the terms of employment”. There is no rupee limit in the clause. There are two conditions in the proviso: the National Tax Number of the hospital or clinic must be given, and the employer must certify and attest the medical or hospital bills.

Part two: a cash medical allowance. A medical allowance is exempt up to ten per cent of your basic salary, but only “if free medical treatment or hospitalization or reimbursement of medical or hospitalization charges is not provided for in the terms of employment”.

In the consolidated text we hold, both parts are printed with the letter (a). The official PDF is the place to confirm the lettering.

How does it work in practice?

Your employer applies this when it works out your monthly tax. Section 149 requires the person paying your salary to deduct tax at your average rate on your estimated income “chargeable under the head Salary” for the year. Exempt medical amounts are not part of that income, so they do not push up the monthly deduction. Amounts that fail the conditions are added to taxable salary.

What matters most is what your appointment letter or company policy says:

Your terms of employment provide	Tax position under clause (139)
Free treatment at a panel hospital	Exempt, if hospital NTN given and bills attested by employer
Reimbursement of your medical bills	Exempt, same conditions, no rupee cap in the clause
Only a fixed medical allowance, no treatment or reimbursement	Allowance exempt up to 10% of basic salary
Reimbursement and also a fixed medical allowance	Reimbursement can be exempt; the allowance does not meet the condition for exemption

Worked example (illustrative figures)

Ayesha works for a trading company in Lahore. Salary is her only income. For tax year 2027 (1 July 2026 to 30 June 2027) her package is:

• Basic salary: Rs. 1,200,000 a year
• Other allowances: Rs. 600,000
• Medical allowance: Rs. 120,000 (Rs. 10,000 a month)

Her contract gives her no free treatment and no bill reimbursement, only the allowance.

Step 1: test the limit. 10% of basic salary is Rs. 1,200,000 x 10% = Rs. 120,000. Her allowance of Rs. 120,000 does not exceed this, so it is exempt.

Step 2: taxable salary. Rs. 1,200,000 + Rs. 600,000 = Rs. 1,800,000.

Step 3: tax. Because salary is more than 75% of her taxable income, clause (2) of Division I of Part I of the First Schedule applies. For income over Rs. 1,200,000 and up to Rs. 2,200,000 the tax is Rs. 6,000 + 11% of the amount above Rs. 1,200,000:

Rs. 6,000 + 11% x Rs. 600,000 = Rs. 6,000 + Rs. 66,000 = Rs. 72,000 for the year.

If the allowance were not exempt (say her contract also promised bill reimbursement), taxable salary would be Rs. 1,920,000 and tax Rs. 6,000 + 11% x Rs. 720,000 = Rs. 85,200. The Rs. 13,200 difference is 11% of the Rs. 120,000 allowance.

What if my allowance is more than 10% of basic salary?

Clause (139) exempts an allowance “not exceeding” ten per cent of basic salary. It does not say in so many words whether an allowance above the limit stays exempt up to 10% with only the excess taxed, or loses the exemption altogether. The Ordinance text we hold does not settle this, so it is a point to confirm with your employer’s payroll or the Commissioner rather than assume.

What if the hospital has no NTN or my employer does not attest the bills?

The proviso makes the NTN of the hospital or clinic and the employer’s certification of the bills conditions of the reimbursement exemption. Clause (139) does not say what happens when they are missing. Without the exemption, a reimbursed personal expense falls under section 12(2)(d), which counts reimbursed expenditure as salary unless it was spent on the employer’s behalf in performing your duties. Medicine for yourself is not an expense of that kind.

Common mistakes

• Treating every medical payment as tax free. Only benefits that fit clause (139) are exempt. Everything else an employer pays you is salary under section 12.
• Claiming the 10% allowance exemption alongside a reimbursement scheme. The allowance exemption only applies where no free treatment or reimbursement is provided for.
• Assuming the 10% is of gross salary. The clause says “basic salary”. House rent, utilities and other allowances are not part of the base.
• Forgetting the paperwork. A reimbursement without the hospital NTN and employer attestation does not meet the proviso.
• Thinking you can deduct your own doctor’s bills from salary. Section 12(4) allows no deduction for expenditure incurred by an employee in deriving salary, and clause (139) covers only what the employer provides or reimburses.

What to check in the official text

• Clause (139) of Part I of the Second Schedule, in the official PDF, for the exact lettering of its two parts and the full proviso.
• Section 12(2)(c) and (d), to see how allowances and reimbursements that are not exempt are treated.
• Your own appointment letter or HR policy: clause (139) turns on what the “terms of employment” provide, so the wording there decides which part of the clause applies to you.
• The salary rate table in clause (2) of Division I of Part I of the First Schedule, if you want to work out the tax on any taxable part.