Indian Income Tax Issues - leaveencashment

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 limit.

Other employees: In case of employees other than government employees, least of the following is exempt under Section 10(10AA)(ii):

a. 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).

Note: 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.

Note:

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.

c. Maximum monetary ceiling specified. At present, it is Rs.25,00,000/- w.e.f. 01.04.2023 (previously Rs.3,00,000).

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.