Leave Encashment or Leave Salary Tax Treatment Sec 10(10AA)
Many organisation provide the facility of encashment of leave (by whatever name called be it earned leave, sick leave etc) either
1) during the period of employment or
2) at the time of retirement (including separation on account of resignation, retrenchment, VRS etc other than termination) of the employee or
3) at the time of Termination of the employee
For tax treatment of leave encashment u/s 10(10AA) of Income Tax Act 1961 the employees has been classified into two types:
1) Govt Employees and
2) Non-Govt employees (PSU employees are considered as non-govt employees)
The tax treatment of Leave encashment is explained with the help of following table:
| S.N | Leave encashment timing | Govt Employees | Non-Govt Employees |
| 1 | During period of service | Fully taxable | Fully taxable |
| 2 | At the time of retirement or separation (other than on account of Termination) | Fully exempt | Exemption is least of the following: 1) Rs 3,00,000 2) Leave encashment amount actually received 3) 10 months’ salary (on the basis ofaverage salary of last 10 months ) * 4) Cash equivalent to leave to the credit of employee at time of retirement ** |
| 3 | At the time of termination of employee | Fully taxable | Fully taxable |
* Here salary means Basic + Dearness Allowance (forms part of pay) + Commission (Fixed % on turnover)
** Cash equivalent to leave to the credit of employee at time of retirement is
= {(A X B) – C} X D
Where
A) No of completed year of service (excluding part of the year)
B) Number of leave credited each year (Subject to maximum of 30 leave per year)
C) Number of leave taken or leave encashed during period of employment
D) Average salary for last 10 months
The following additional points should be noted:
i. Where leave salary is received from two or more employers in the same year, then the aggregate amount of leave salary exempt from tax cannot exceed Rs 3,00,000
ii. Where leave salary is received in any earlier year from a former employer and again received from another employer in a later year, the limit of Rs 3,00,000 will be reduced by the amount of leave salary exempt earlier.
iii. Relief u/s 89 read with Rule 21A can be claimed by the employee in cases where the amount of leave encashment is fully taxable.
iv. Leave salary (or leave encashment) received by the legal heir of the deceased employee is not at all taxable in the hands of his legal heirs (F.35/1/65-IT(B), dated 5-11-1965)
The treatment of leave salary can be explained with the help of an example:
Example: Mr. Gupta retired on 1.12.2014 after 20 years 10 months of service, receiving leave salary of Rs 5,00,000.
Other details of his salary income are:
Basic Salary : Rs 5,000 p.m.(Rs 1,000 was increased w.e.f. 1.4.2014)
Dearness Allowance : Rs 3,000 p.m. (60% of which is for retirement benefits)
Commission : Rs 500 p.m.
Bonus : Rs 1,000 p.m.
Leave availed during service : 480 days
He was entitled to 30 days leave every year.
What will be the taxable leave salary assuming:
(a) He is a government employee.
(b) He is a non government employee.
Solution:
(a) He is a government employee.
Leave Salary received at the time of retirement Rs 5,00,000
Less : Exemption under section 10(10AA) Rs 5,00,000
Taxable Leave salary Nil
(b) He is a non-government employee
Leave Salary received at the time of retirement Rs 5,00,000
Less : Exempt under section 10(10AA) [See Note below] Rs 26,400
Taxable Leave Salary Rs 4,73,600
Exemption is least of the following:
1) Statutory Limit Rs 3,00,000
2) Leave encashment amount actually received Rs 5,00,000
3) 10 months’ salary
{(5000*8)+(4000*2)+(60% of 3,000 *10)*10}/10 Rs 66,000
4) Cash equivalent to leave to the credit of employee at time of retirement
((20*30)- 480)*(6600/30) Rs 26,400
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