Income Tax

Leave Encashment – Exemption and Tax liability:-

Introduction –

During the service period, you are allowed various types of leaves e.g. Sick leave, Casual Leave, Earned Leave, etc. Sick leaves and casual leaves cannot be carried forward to the next years. But earned leaves can be accumulated and carried forward to the next years.

Sometimes the employees cannot avail of all these earned leaves which were allowed to him by the employer. He can encash these leaves and earn a salary for the number of days that were allowed to be taken as leaves. The number of leaves allowed to be taken and the leave encashment varies from employer to employer as per their policies.

An employee can avail leave encashment as below given events-

  • During the continuation of service.
  • At the time of retirement, superannuation or resignation.

Tax liability and exemption under section 10 (10AA) of Income Tax Act, 1961 for Leave Encashment-

Leave encashment received during the continuation of service is always taxable. No exemption is allowed. After the death of the employee, any sum of money received by the family members of the deceased person is not taxable in the hands of family members.

Leave Encashment – Exemption and Tax liability
Leave Encashment – Exemption and Tax liability

Leave encashment received by the employees at the time of retirement or superannuation or resignation-

For Govt. Employees-

Leave encashment at the time of retirement or superannuation received by a Govt. employee, is fully exempted.

For Example:

Mr. Rahul is a government employee and he is entitled to 30 days leave per year. His outstanding earned leaves are 250. At the time of retirement, he received Rs. 10,00,000 on account of leave encashment. What is the tax liability?

Solution:

Mr. Rahul is a Government employee and amount received of Rs. 10,00,000 on his retirement is fully tax-free.

For other Employees-

Leave encashment at the time of retirement or superannuation or otherwise received by an employee other than a government employee, is exempt to the extent of a certain limit.

Least of the following is exempt from tax-

  • Leave Encashment actually received.
  • 10 months average salary
  • A Cash equivalent of unveiled leave calculated on the basis of maximum 30 days leave for every year of completed service.
  • Rs. 3,00,000

However, please note the below:
Salary = Basic Salary+ Dearness Allowance + Commission if paid on a percentage of the sale.

Average Salary means salary earned by an employee immediately preceding 10 months from the date of retirement from service. Unveiled leave calculated on the basis of a maximum of 30 days leaves for every year of completed services.

  1. If employer allowed entitling for leave encashment of 40 days, leave calculated on the basis of maximum 30 days or if the employer allowed entitling for leave encashment of 28 days leave calculated on the basis of 28 days.
  2. If an employee receives leave encashment from more than one employer, the amount of exemption will be calculated independently in respect of each employer.
    The total amount of exemption could not exceed Rs.3, 00,000/- during his lifetime.

For Example:
Mr. Pranav is a Non-Government employee and he is entitled to 35 days leave per year. He availed 630 days leave during his service tenure. He rendered 30 years 8 months in an organization. At the time of retirement
Basic Salary of Mr. Pranav was Rs. 60,000 and Dearness Allowance was Rs. 20,000 from the past 10 months. At the time of retirement, he received Rs. 10,00,000 on account of leave encashment. What is the tax liability?

Solution:

  1. Leave encashment actually received i.e. Rs. 10,00,000
  2. 10 months average salary @ (60,000+20,000) i.e. 80,000 PM x 10 months = 8,00,000
  3. Cash equivalent of unveiled leave on the basis of 30 days leave for every completed year of service = 30 days x 30 years = 900
    Less: Already availed = 630
    Balance unveiled leave = 270 i.e. 09 months
    Amount comes to Rs. = 09 months * 80,000 per month = 7,20,000
  4. Rs. 3,00,000

The exempted amount is least of the above which is Rs. 3,00,000

Tax implication on leave encashment –
Amount actually received = Rs. 10,00,000
Less: Exempt under section 10(10AA) = Rs. 3,00,000
Balance Taxable Amount = Rs. 7,00,000

Source
Direct taxation, ICAI 2019

TaxClue Team

Taxclue is an online news portal for reporting all news, articles, judgments, Circulars, orders, and notifications relating to various corporate and tax laws in India. We use the tagline ‘Simplifying Laws’. Our mission is to Simplify the Laws and make people aware of their rights and duties in relation to tax matters in order to equip them to participate in nation-building. TaxClue is a team of young professionals. We started in December 2016 with the mission of knowledge sharing. TaxClue would like to hear your valuable suggestion. Please write to our editorial team at [email protected]

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