Key Highlights
- Leave encashment during service: fully taxable for all employees
- Leave encashment at retirement: Government employees — fully exempt
- Leave encashment at retirement: Private sector — exempt up to Rs 25 lakh (enhanced from Rs 3 lakh by Finance Act 2023)
- On death of employee: Leave encashment to legal heir — fully exempt
- Rs 25 lakh is a lifetime aggregate limit — across all employers
- Exemption under Schedule II, ITA 2025
Legal Reference
Schedule II (leave encashment exemption), ITA 2025 | Finance Act 2023: enhanced private sector limit to Rs 25 lakh | Corresponds to Section 10(10AA) of ITA 1961
1. Leave Encashment: When is it Taxable?
| Situation | Government Employee | Private Sector Employee |
|---|
| Encashment during service (any time) | Fully taxable | Fully taxable |
| Encashment at retirement/superannuation | Fully exempt | Exempt up to Rs 25 lakh |
| Encashment on voluntary retirement (VRS) | Fully exempt | Exempt up to Rs 25 lakh |
| Encashment to legal heir on death | Fully exempt | Fully exempt (no limit) |
2. Private Sector Exemption Formula
For private sector employees at retirement, the exempt leave encashment is the lowest of:
- Actual amount received
- Rs 25,00,000 (lifetime limit)
- Cash equivalent of leave to the credit at retirement (leave earned × last drawn salary per day, limited to 30 days per year of service)
- 10 months average salary (last 10 months average)
3. Leave Encashment Example
Illustrative only. Sunita retires from a private company after 25 years. Leave to credit at retirement = 300 days. Last drawn salary = Rs 1,00,000/month. Average last 10 months salary = Rs 95,000/month.
- Actual leave encashment = Rs 10 lakh (300 days × Rs 3,333/day)
- Rs 25 lakh (statutory limit)
- Leave × salary: 300 × 1,00,000/30 = Rs 10 lakh
- 10 months average salary = 10 × 95,000 = Rs 9.5 lakh
- Exemption = lowest of Rs 10L, Rs 25L, Rs 10L, Rs 9.5L = Rs 9.5 lakh
- Taxable leave encashment = Rs 10L − Rs 9.5L = Rs 50,000
4. Rs 25 Lakh: Lifetime Aggregate
The Rs 25 lakh exemption is a cumulative lifetime limit — if you have changed jobs and claimed leave encashment exemption from a previous employer, the balance available from the Rs 25 lakh lifetime limit is reduced accordingly. Maintain records of leave encashment exemption claimed from all employers throughout your career.
5. Why TaxClue
Leave encashment at retirement involves a multi-formula exemption calculation that must be computed correctly. TaxClue ensures the correct exemption is claimed in your ITR, with proper documentation. Contact us for retirement benefit tax computation and ITR filing.
Disclaimer
This article is for general informational and educational purposes only. It does not constitute legal, financial, or professional tax advice. Readers are advised to consult a qualified Chartered Accountant or tax professional before making any decisions. TaxClue Consultech Pvt Ltd accepts no liability. All case studies and examples in this article are illustrative only and do not represent actual persons or transactions.
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❓ Frequently Asked Questions
Is leave encashment taxable in India?
Leave encashment received during service (while still employed) is fully taxable at slab rates for all employees. Leave encashment received at retirement or superannuation is exempt for government employees (fully) and for private sector employees up to Rs 25,00,000 (lifetime limit) under Schedule II of the Income Tax Act, 2025. Leave encashment paid to a legal heir on death is fully exempt.
What is the leave encashment exemption limit for private sector employees?
Private sector employees can claim exemption of up to Rs 25,00,000 on leave encashment received at retirement under Schedule II of ITA 2025. This was enhanced from Rs 3,00,000 by Finance Act 2023. The actual exempt amount is the lowest of: actual amount received; Rs 25 lakh; cash equivalent of leave at credit (30 days per year × salary); and 10 months average salary. The Rs 25 lakh is a lifetime aggregate across all employers.
Is leave encashment during service taxable?
Yes. Leave encashment received during service — whether you cash in earned leave while still employed (which many companies allow annually) — is fully taxable as salary income at slab rates for all employees, including government employees. The exemption under Schedule II applies only to leave encashment at the time of retirement, superannuation, or voluntary retirement — not to periodic encashment during service.
Is leave encashment paid on death of employee exempt?
Yes. Leave encashment paid to the legal heir or nominee of a deceased employee is fully exempt from tax — there is no monetary ceiling under Schedule II of ITA 2025. The full amount, regardless of quantum, is exempt. This ensures the bereaved family is not burdened with income tax on the terminal settlement amount received.
What was the Finance Act 2023 change in leave encashment?
Finance Act 2023 significantly enhanced the leave encashment exemption limit for non-government employees from Rs 3,00,000 to Rs 25,00,000. This change was made after decades during which the Rs 3 lakh limit had remained unchanged despite significant growth in salaries. The enhanced Rs 25 lakh limit is carried forward into Schedule II of the Income Tax Act, 2025 and applies for Tax Year 2026-27.
