I received salary arrears this year; can they be taxed at the rates of the year I earned them?

Salary arrears are taxed in the year you receive them, but the Income Tax Ordinance gives you a choice about the rates. If adding the arrears to this year’s salary pushes you into a higher slab than you would have faced had they been paid on time, section 12(7) lets you elect the older year’s rates instead. The election is not automatic: you make it in writing, before a deadline.

What does the law say?

Section 12(1) charges salary “received by an employee in a tax year” in that year. Arrears paid in tax year 2027 for work done in tax year 2026 are therefore tax year 2027 income by default.

Section 12(7) creates the relief. It applies where two conditions are both met:

1. an amount chargeable as salary “is paid to an employee in arrears”; and
2. “as a result the employee is chargeable at higher rates of tax than would have been applicable” had it been paid in the year the services were rendered.

When both hold, the employee may, “by notice in writing to the Commissioner”, elect for the arrears to be taxed at the rates that would have applied in the year the services were rendered.

Section 12(8) sets the time limit. The election must be made by the due date for furnishing the employee’s return of income or employer certificate for the tax year in which the amount was received, or by a later date the Commissioner allows. Section 118(3) makes 30 September after the end of the tax year the due date for an individual’s return. For arrears received between 1 July 2026 and 30 June 2027 (tax year 2027), that is 30 September 2027, unless extended.

How does it work in practice?

Your employer deducts tax on salary under section 149 at your average rate on your estimated salary for the tax year in which the payment is made, computed at the rates in Division I of Part I of the First Schedule. Arrears paid this year are salary received this year, and section 149 does not refer to the section 12(7) election. Section 12(7) is an election you make to the Commissioner, not an instruction to your employer, so the relief is claimed through your own return and notice. Any tax deducted beyond what you finally owe is a refund matter.

The Ordinance does not set out a formula for working out “the rates of tax that would have been applicable” to the arrears. One way to read it, used in the example below, is to compare the extra tax the arrears cause in each year. Because the Ordinance does not settle the method, a figure worked out this way is not certain.

Worked example (illustrative figures)

Sana works for a public sector body in Islamabad. In tax year 2027 her regular salary is Rs. 2,200,000. After a pay revision she also receives Rs. 600,000 of arrears for work done in tax year 2026, when her salary was Rs. 1,000,000. All amounts are invented.

The rates are real. Tax year 2027 uses the table in clause (2) of Division I, Part I, First Schedule, as amended by the Finance Act, 2026. Tax year 2026 uses the table the Finance Act, 2026 replaced, which the source PDF prints in the footnote to that clause.

Taxable salary	Tax year 2026 table	Tax year 2027 table
Up to Rs. 600,000	0%	0%
Rs. 600,001 to 1,200,000	1% of amount over 600,000	1% of amount over 600,000
Rs. 1,200,001 to 2,200,000	6,000 + 11% over 1,200,000	6,000 + 11% over 1,200,000
Rs. 2,200,001 to 3,200,000	116,000 + 23% over 2,200,000	116,000 + 20% over 2,200,000
Rs. 3,200,001 to 4,100,000	346,000 + 30% over 3,200,000	316,000 + 25% over 3,200,000
Above Rs. 4,100,000	616,000 + 35% over 4,100,000	541,000 + 29% (to 5,600,000), then higher bands

Without the election (arrears taxed in tax year 2027):

1. Salary plus arrears: 2,200,000 + 600,000 = 2,800,000
2. Tax: 116,000 + 20% of 600,000 = 116,000 + 120,000 = 236,000
3. Tax on regular salary alone: 6,000 + 11% of 1,000,000 = 116,000
4. Extra tax caused by the arrears: 236,000 - 116,000 = Rs. 120,000

With the election (arrears at tax year 2026 rates):

1. Tax year 2026 salary plus arrears: 1,000,000 + 600,000 = 1,600,000
2. Tax on that: 6,000 + 11% of 400,000 = 6,000 + 44,000 = 50,000
3. Tax on tax year 2026 salary alone: 1% of 400,000 = 4,000
4. Extra tax caused by the arrears: 50,000 - 4,000 = Rs. 46,000

On this reading, Sana’s arrears cost Rs. 46,000 at the earlier year’s rates against Rs. 120,000 at this year’s rates, a difference of Rs. 74,000. Both conditions in section 12(7) are met: the arrears were paid late, and they pushed her into a higher rate.

What if …?

The arrears cover several past years? Section 12(7) refers to “the tax year in which the services were rendered”. Where arrears relate to more than one year, each portion relates to its own year. The Ordinance does not spell out the apportionment.

My earlier year’s income was higher than this year’s? Then the condition in section 12(7)(b) may not be met, because paying the arrears now does not push you into higher rates. The election is only available where it does.

I missed 30 September? Section 12(8) allows the election “by such later date as the Commissioner may allow”. Whether a later date is allowed is the Commissioner’s decision.

Common mistakes

• Assuming the employer applies old rates. The election in section 12(7) is made by the employee to the Commissioner.
• Thinking arrears belong to the old year’s return. Section 12(1) taxes salary in the year received. Only the rates change.
• Assuming the old year is always cheaper. The tax year 2027 table charges less than the tax year 2026 table on income above Rs. 2,200,000. Whether the election helps depends on the salary in both years.

What to check in the official text

Read section 12(7) and (8) together, and section 118(3) for the return due date. Take both rate tables from the source PDF of the First Schedule: the current clause (2) table, and the footnoted table for the earlier year. If your arrears relate to tax year 2025 or earlier, use the table in force for that year, which appears in the earlier footnotes to the same clause.