Leave encashment is the payment received in respect of any
period of leave not availed by the employee. In terms of Section 17(1)(va), leave encashment is part of salary
and is taxable as salary. However, in terms of Section 10(10AA), leave encashment at the time of
retirement/superannuation is exempt subject to some limits and conditions. Meaning that, leave encashment is
taxable while the employee is in service but relief under section 89 can be claimed.
Government Employees: In case of government employees (central/state), leave
encashment at the time of retirement/superannuation is exempt from tax under Section 10(10AA)(i) without any
Other employees: In case of employees other than government employees, least
of the following is exempt under Section 10(10AA)(ii):
Leave encashment in respect of the period of earned
leave standing to the credit of the employee at the time of retirement/superannuation. (earned leave encashment not
to exceed 30 days for every year of actual service rendered for the employer).
Cash equivalent of leave to
the credit of the employee has to be ascertained through average salary. Average salary
means the salary calculated on the basis of average salary drawn for the period of 10 months
immediately preceding the month of retirement, whether on superannuation or otherwise. This
is to be calculated as the number of months (maximum 30 days per year) leave to the credit
of the employee multiplied by the average salary. It is to be noted that the leave
encashment calculated as such is different from the actual amount received.
10 months’ average salary
Ø Average salary means salary calculated on
the basis of average salary drawn during the period of 10 months immediately preceding the
month of retirement/superannuation.
Ø Salary means basic salary and includes
dearness allowance entered into service benefits but excludes all other allowances and
perquisites. But as a party of salary if commission is payable as a fixed percentage of
turnover achieved by an employee, such commission also forms part of salary.
Maximum monetary ceiling specified. At present, it
is Rs.25,00,000/- w.e.f. 01.04.2023 (previously Rs.3,00,000).
Amount actually received.
Other points to be noted:
Receipt from more than one employer:
In case the employee receives cash equivalent
of non-utilised earned leave from more than one employer in the same year, the maximum exemption shall not
exceed the amount arrived at being the least of the above amounts.
Leave encashment paid to family on death of
employee: In case the cash equivalent
of non-utilised earned leave is paid to the family on the death of an employee, it is not in the nature of
employer to employee. The deceased has no right or interest in this receipt. The payment is only by way of
financial benefit to the family of the deceased government, which would not have been due or paid had the
government servant been alive. In view thereof, the amount will not be taxable to income tax. Vide circular
No.309, dated 3.7.1981.
Leave salary in the hands of legal representative:
The leave salary paid to the legal heirs of the
deceased employee in respect of privilege leave standing to the credit of such employee at the time of his death
is not taxable as salary. Vide Letter No.35/1/65-IT(B), dated 5.11.1965.