Leave Encashment [Section 10(10AA)]

Exempted Incomes-Section 10(10AA)

Leave encashment refers to the practice of converting accumulated leave into cash. Many organizations provide their employees with the option to encash their unused leave days. However, when it comes to the tax treatment of leave encashment, there are certain rules and regulations that need to be followed.

In India, the tax treatment of leave encashment is governed by Section 10(10AA) of the Income Tax Act. According to this section, leave encashment received by a government employee at the time of retirement is fully exempt from tax. However, for non-government employees, the tax treatment varies depending on various factors.

For non-government employees, the tax treatment of leave encashment can be categorized into two scenarios:

(1)        Leave encashment received at the time of retirement :

Leave encashment received by an employee during employment is fully taxable.

(2)        Leave encashment received during the course of employment :  

Leave encashment received by an employee at the time of retirement (on superannuation or otherwise) is partly exempt from tax under Section 10(10AA). The maximum amount of leave encashment that is exempt from tax is Rs. 3 Lakh [ Rs. 25 lakh (as per the Budget 2023)]. The exemption is calculated as follows:

[Exempt amount = Average salary * Number of earned leave days encashed]

Average salary is the average of the salary drawn in the last 10 months immediately preceding the date of retirement.

Number of earned leave days encashed is the number of earned leave days that are encashed at the time of retirement.

Exemption:

Exemption of leave encashment at the time of retirement u/s 10(10AA)

Govt. employee i.e. Central and State Govt. employees Any other Employee
Fully exempt

 

Minimum of the following four limits:

(i)         Leave encashment actually received; or

(ii)        10 month’s average salary; or

(iii)       Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of actual service rendered;
or

(iv)       Rs. 3,00,000

[ Note : Rs.25,00,000 ((as per the Budget 2023)]

Meaning of salary

(i)         Basic salary plus D.A. to the extent the terms of employment so provide plus Commission, if fixed percentage of turnover.

(ii)        Average salary of last 10 months immediately preceding the date of retirement.

Amount specified by the Government from time to time is given in the table below:

Date of Retirement Rs.
Between 1-1-1988 and 3 1-3-1995 79,920
Between 1-4-1995 and 30-6-1995 1,30,320
Between 1-7-1995 and 1-7-1997 1,35,360
After 1-7-1997 and upto 1-4-1998 2,40,000
After 1-4-1998 3,00,000
1.         If the employee had received leave encashment in any one or more earlier previous year(s) also and had availed of the exemption in respect of such amount, then the limit given in clause (d), specified above, shall be reduced by the amount of exemption(s) availed earlier.

2.         Where the leave encashment is received by the employee from more than one employer in the same previous year, the specified limit given in clause (d) above would apply to the aggregate of leave encashment received from one or more employers.

3.         Leave salary received by the family of a government servant, who died in harness, is not taxable in the hands of the recipient. [Circular Wo. 309, dated 3.7.1981].

4.         Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is an ex-gratia payment on compassionate grounds in the nature of gifts. Thus the payment is not in the nature of salary. [Letter No. 35/1/65, dated 5.11.1965].

5. The assessee can claim relief from tax under section 89 in respect of leave encashment.

 Example :

E, an employee of XYZ Pvt. Ltd. retired from the company on 30.11.2021. At the time of his retirement, he received 2,88,000 as leave salary from his employer. The following information is provided by the employee:

Rs.
(1) Salary at the time of retirement (p.m.) 18,000
(2) Period of Service 20 years & 8 months
(3) Leave encashment 2,88,000
(4) Leave availed while in service 14 months
(5) Balance unavailed leave at the time of retirement 16 months
(6) Average salary for the months of February, 2021 to November, 2021 17,600
(7) Leave entitlement 11/2 month for every completed year of service

Compute the amount of taxable leave encashment.

Solution:

The minimum of the following four amounts will be exempt:

(a)        Leave encashment actually received =  Rs.  2,88,000

(b)        10 months’ average salary, i.e., Rs. 17,600 x 10 = Rs. 1,76,000

(c)        Leave encashment for 6 months @ Rs. 17,600 p.m. = Rs. 1,05,600.

(d)        Amount specified by the Government, i.e., Rs. 3,00,000

Hence Rs. 1,05,600 would be exempt and the balance of Rs. 1,82,400 would form part of gross salary.

Although he is entitled to 1 1/2 month’s leave for every completed year of service, for the purpose of calculating limit for clause (c) above, the calculation will be done on the basis of maximum 30 days’ leave for every completed year of service. Therefore, the maximum leave allowable for purpose of clause (c), i.e., 30 days x 20 =  600 days, i.e., 20 months. Leave already availed by employee is 14 months. Therefore, the unavailed leave calculated on basis of 30 days leave for every completed year of service is 6 months (20 – 14).

Important Points to note

  • The exemption for leave encashment is available only to employees. It is not available to self-employed individuals.
  • The exemption is available only for leave encashment received at the time of retirement. It is not available for leave encashment received during employment.
  • The exemption is available for leave encashment received from any employer, whether government or non-government.
  • The aggregate amount of leave encashment exempt from tax under Section 10(10AA) cannot exceed Rs. 25 lakh, even if the employee receives leave encashment from multiple employers in the same or different years.
See also  Income received from Securitisation Trust is Exempt from Tax [Section 10(35A)]
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