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TaxCalc.pk
FY 2026-27
Guide to taxing advance rent and unadjustable tenancy deposits in Pakistan under Section 16. Master the 10-year allocation rule, refunds & Iris filing.
By Syed Asad Hussain Zaidi · 9 September 2026
[Tax Year 2027 Statutory Directive]: Under Section 16 of the Income Tax Ordinance, 2001, any amount received by a landlord from a tenant that is not adjustable against rent—commonly known as non-refundable security deposits, earnest money, or commercial pagri—is treated as rental income and allocated in equal proportions across ten consecutive tax years. Confusing refundable security deposits with unadjustable deposits or miscalculating Section 16(2) turnover deductions upon early tenant eviction triggers substantial tax adjustments and FBR audit penalties.
[Tax Year 2026 Framework]
- Updated for FY 2026 compliance.
- Reflects current FBR and SECP statutory requirements.
Real estate tenancy agreements in Pakistan frequently incorporate substantial upfront financial transfers. These payments generally take two forms: advance rent adjustable against future monthly invoices, and lump-sum unadjustable deposits paid at the execution of the lease.
While landlords often assume that unadjustable deposits represent capital receipts or security funds outside the scope of income taxation, Section 16 of the Income Tax Ordinance, 2001 categorizes these receipts as taxable rental income. Understanding the mechanics of statutory allocation, tenant turnover adjustments, and drafting compliant lease covenants is vital for preserving after-tax yields.
The tax treatment of upfront tenancy funds hinges upon whether the capital is legally adjustable against future rent obligations:
When a tenant pays six months or one year of rent in advance, and this sum is systematically credited against each succeeding month's rental bill, the payment constitutes ordinary rental income under Section 15.
Section 16 exclusively governs any sum received by a landlord from a tenant that is not adjustable against the rent payable by the tenant. This encompasses:
┌─────────────────────────────────────────────────────────────────────────┐
│ UPFRONT TENANCY PAYMENT CLASSIFICATION │ └─────────────────────────────────────────────────────────────────────────┘ │ Is the payment adjustable against rent? │ ┌─────────────────┴─────────────────┐ ▼ ▼ [YES] [NO] │ │ Ordinary Advance Rent (Sec 15) Is the amount refundable Taxed in year received/accrued upon lease termination? Subject to Sec 15A deductions │ ┌──────────┴──────────┐ ▼ ▼ [YES] [NO] │ │ True Security Section 16 Deposit Unadjustable (Non-taxable Deposit Capital Liability) Allocated over 10 consecutive tax years (1/10th)
Recognizing that taxing a massive unadjustable deposit in a single tax year would unfairly shove the landlord into the maximum 35% tax bracket (bracket creep), Parliament enacted Section 16(1) to provide relief through amortization:
"Where the owner of a building receives from a tenant any amount which is not adjustable against the rent payable by the tenant, the amount shall be treated as rent chargeable to tax under the head 'Income from Property' in equal proportions in the tax year in which it is received and the following nine tax years."
Under this statutory formula, exactly one-tenth (10%) of the unadjustable amount is added to the landlord's gross rental income each year for ten consecutive tax years.
In July 2026 (Tax Year 2027), a commercial landlord in Blue Area, Islamabad leases a corporate retail space. Under the tenancy agreement:
Annual Rental Revenue Calculation (Tax Year 2027):
- Actual Monthly Rent Received (12 × PKR 500,000) = PKR 6,000,000
- Section 16(1) Unadjustable Allocation (PKR 20,000,000 ÷ 10) = PKR 2,000,000
────────────────────────────────────────────────────────────────────────────
Total Gross Chargeable Rent under Section 15 = PKR 8,000,000 Less: 20% Statutory Repair Allowance under Sec 15A(1)(a) = (PKR 1,600,000) ──────────────────────────────────────────────────────────────────────────── Net Taxable Property Income for Tax Year 2027 = PKR 6,400,000
The landlord continues to declare this PKR 2,000,000 deemed rental tranche in each tax year from Tax Year 2027 through Tax Year 2036, regardless of changes in regular monthly rent, provided the tenancy remains in force.
Tenancy relationships rarely endure undisturbed for ten full years. Tenants vacate early, businesses relocate, or leases terminate by mutual consent. Section 16(2) provides the precise statutory mechanism for handling early termination and subsequent tenancies.
When a tenant vacates before the expiry of the ten-year cycle:
Under Section 16(2), where a landlord receives a new unadjustable deposit from a successive tenant, the taxable portion of the new deposit is reduced by the amount of the previous deposit that was already taxed under Section 16:
$ ext{Taxable New Deposit} = ext{New Deposit} - sum ( ext{Previously Taxed Tranches of Old Deposit})$
The net figure resulting from this subtraction is then divided by ten and allocated over the subsequent ten tax years.
Case Study: Successive Unadjustable Tenancies
• Year 1 (Tax Year 2025): Landlord receives PKR 10,000,000 unadjustable deposit from Tenant A. - Taxed in TY 2025: PKR 1,000,000 - Taxed in TY 2026: PKR 1,000,000 - Total previously taxed: PKR 2,000,000 • Year 3 (Tax Year 2027): Tenant A vacates. Landlord leases to Tenant B and receives PKR 15,000,000 unadjustable deposit.
Computation of Section 16 Taxable Base for Tenant B: New Unadjustable Deposit Received = PKR 15,000,000 Less: Amount of previous deposit already taxed (2 × 1M) = (PKR 2,000,000) ──────────────────────────────────────────────────────────────────────────── Adjusted Unadjustable Base for Section 16 Allocation = PKR 13,000,000
Annual Addition to Rent for Next 10 Years (TY 2027–2036) = PKR 1,300,000 / year
This vital statutory reduction protects the landlord from compounding tax liabilities on the same physical real estate asset.
The most frequent tax dispute between landlords and FBR assessment officers centers on refundable security deposits.
Under standard commercial leasing practice, a tenant deposits three to six months of rent as a refundable security deposit, designed to cover potential utility arrears or physical property damage upon lease termination.
Statutory Reality: A genuine, refundable security deposit does not fall under Section 16. It is a capital liability on the landlord's balance sheet (and Form 116 Wealth Statement). It is not income, and it is not subject to the 10-year allocation rule.
However, during FBR desk audits under Section 177 or show-cause proceedings under Section 122, aggressive auditors routinely scan tenancy agreements. If the agreement contains ambiguous language regarding refunds, auditors arbitrarily classify the entire security deposit as an unadjustable payment under Section 16, adding 10% to the landlord's taxable income and slapping penalties for non-declaration.
| Receipt Type | Governing Section | FBR Tax Treatment | Allocation Period | Withholding Tax Duty | |---|---|---|---|---| | Regular Monthly Rent | Section 15 | Ordinary property income; taxed progressively | Current tax year (Accrual or Cash) | Section 155 applies if tenant is prescribed | | Adjustable Advance Rent | Section 15 | Taxable in full as property income | Current tax year received/accrued | Section 155 applies upon payment | | Unadjustable Deposit (Pagri) | Section 16 | Taxable as property income | Amortized equally over 10 years (10% / year) | Section 155 does not apply (capital deposit) | | Refundable Security Deposit | Exempt (Capital Liability) | Zero Income Tax. Reported as liability on Form 116 | Indefinite until refunded | Exempt from withholding |
When reporting unadjustable advance receipts on the FBR Iris portal, execute the following steps to ensure proper statutory compliance:
Step 1: Open Iris Return Form 114 for Tax Year 2027
│ ├─► Step 2: Access "Income from Property" -> "Other Receipts" │ • In Code 2002 ("Unadjustable Advance Received under Section 16"), enter the 1/10th tranche. │ • Do NOT enter the total gross deposit received (entering PKR 20M instead of PKR 2M │ will erroneously inflate your immediate tax liability ten-fold). │ ├─► Step 3: Attach Tenancy Schedule in Iris Notes │ • Upload PDF copy of the signed lease agreement establishing the deposit terms. │ • Include historical schedule tracking past years' taxed tranches. │ ├─► Step 4: Wealth Statement (Form 116) Reconciliation │ • Under "Inflows", report the full cash received from the tenant. │ • Under "Liabilities" (Code 7000), declare the unamortized balance of the deposit. │ • Confirm Net Wealth reconciliation matches to zero discrepancy. │ └─► Step 5: Verification of Section 15A Repairs • Ensure that the 20% statutory repair allowance (Code 2003) is applied against the aggregated total (Monthly Rent + Section 16 Annual Allocation).
### TaxCalc Advisory Insights: Commercial Pagri Traps
"In Pakistan's traditional commercial hubs—such as Anarkali and Mall Road in Lahore, or Saddar and Bolton Market in Karachi—pagri transactions involve tens of millions of rupees. The greatest danger arises when a landlord receives cash pagri and attempts to integrate it into white capital without declaring it under Section 16.
> When the landlord attempts to purchase banking instruments or real estate with these funds, the FBR issues a Section 111(1)(b) notice for unexplained cash credits. Under Section 111, unexplained receipts are taxed in full in a single tax year at punitive rates with a 100% penalty. Declaring unadjustable deposits under Section 16 provides an ironclad statutory path: you pay tax on only 10% per year, completely legitimize the capital inflows, and maintain perfect wealth statement balance."
> — Syed Asad Hussain Zaidi, Advocate High Court | Founder, TaxCalc.pk
A vital legal nuance frequently overlooked by corporate tenants and landlords is whether Section 155 withholding tax applies to unadjustable deposits.
Under Section 155, prescribed persons (companies, AOPs, institutions) must deduct withholding tax when paying rent to an individual or corporate landlord. However, an unadjustable advance deposit paid at lease inception is not rent paid for occupation; it is a capital deposit statutorily converted into deemed rental income over ten years.
Therefore, corporate tenants have no statutory mandate to deduct Section 155 withholding tax from the lump-sum unadjustable security deposit or pagri. Withholding applies exclusively to the monthly rental invoices as they fall due. Corporate accounts departments that erroneously deduct 15% from unadjustable deposits starve landlords of legitimate capital and generate severe reconciliation hurdles on Iris.
If you are negotiating a major commercial lease, receiving substantial unadjustable tenancy deposits, or facing an FBR audit challenging your security deposits, professional legal guidance is indispensable.
Utilize our Rent Withholding Tax Guide for transactional compliance, consult the Tax Year 2027 Slabs, or engage our legal chambers for Drafting Legal Agreements & Contracts and Income Tax Return Filing.
Legal & Statutory Notice: The information provided in this publication is for general educational, academic, and statutory informational purposes only under the relevant laws of Pakistan (including the Income Tax Ordinance, 2001, the Companies Act, 2017, and the Trade Marks Ordinance, 2001). This content does not constitute formal legal, financial, or tax advice. For specific assessments, consult a licensed Advocate or qualified tax professional.