Taxability of Leave Encashment
Last Updated : Dec. 5, 2016, 12:12 p.m.
Leaves are an important part of an employee’s work life. It’s important for survival! However, there are employees who are not able to avail the leaves available to them. This can happen due to various reasons such as pressure of work, at times addictiveness to work.
Luckily enough, there are some types of leaves which can be carried forward to the next year. whereas there are some leaves which cannot be carried forward to the next year. However, in case the employee does not avail all the leaves which were allowed to him, he may also encash these leaves and earns salary for the number of days which were allowed to be taken as leaves but were not availed as leave.
Taxability of Leave Encashment Salary
Leave encashment is taxable as salary if received while in service. Leave encashment received at the time of retirement is exempt in the hands of the Government employee. In the hands of non-Government employee leave encashment will be exempt subject to the limit prescribed in this behalf under the Income-tax Law.
Section 10(10AA)(i)- FULL EXEMPTION
As per this section, any payment received by an employee of the Central Government or a State Government as leave encashment at his credit at the time of his retirement whether on superannuation or otherwise is exempt from tax.
Section 10(10AA)(i)- FULL OR PARTIAL EXEMPTION
As per this section, the least of the following is exempt from tax:
- INR 300,000; or
- Actual leave encashment amount received from the company; or
- 10 months’ average salary; or
- Cash equivalent of leaves that are lying credit to an employer’s credit, at the time of retirement
For ease of understanding, I have bifurcated the taxability of leave salary for various categories of employees as follows:
- Government employee:
| Type of Leave Encashment | Chargeability to Tax |
|---|---|
| Leave encashment during continuity of employment | It is chargeable to tax under the head “Salary” |
| Leave encashment at the time of retirement / leaving job | It is fully exempt from tax under section 10(10AA) |
Illustration:
- Received during the course of employment: Mr. Prakash is a government employee and he is entitled to get 25 leaves per year. He has credit of 252 days leaves’ in his account. During the year 2012-13, he encashed leaves of 52 days and received INR 65,000 on account of leave encashment salary. In such case, INR 65,000 will amount to leave encashment salary and would be fully taxable as received during the continuation of employment.
- Received at the time of retirement: Mr. Prakash is a government employee. He is entitled to 28 days’ leaves per year. He has credit of leaves of 484 days in his account. He retired in the year 2012-13 and received INR 484,000 on account of leave encashment at the time of retirement. In this case, INR 484,000 will amount to leave encashment at the time of retirement and will be fully exempt from tax as received at the time of retirement.
B. Non-Government Employee
| Type of Leave Encashment | Chargeability to Tax |
|---|---|
| Leave encashment during continuity of employment | It is chargeable to tax under the head “Salary” |
| Leave encashment at the time of retirement / leaving job | It is fully or partially exempt from tax in some cases under section 10(10AA) (ii) |
Illustration:
- Received during the course of employment: Mr. Shyam is working in HDFC Ltd. He is entitled to 28 days’ leave per year. He has credit of leave of 384 days in his account. During the year 2012-13 he encashed leave of 84 days and received INR 84,000 on account of leave encashment. In this case, INR 84,000 will amount to encashment of leave during the continuation of service and will be fully taxed in his hands.
- Received at the time of retirement: Mr. Abhimanyu retired on 1 st December 2012 after serving for 20 years and 10 months, receiving leave salary of INR 500,000. The other details are as follows:
- Basic salary: INR 50,000 per month
- Dearness Allowance: INR 3,000 per month (60% of the same forms part of retirement benefits)
- Commission: INR 500 per month
- Bonus: INR 1,000 per month
- Leaves availed during the service: 480 days (He was entitled to avail 30 days leave every year)
His taxable leave salary would be computed in the following way, assuming he is a non-government employee:
Exemption under Section 10(10AA) is least of the following:
- Leave salary received: INR 500,000
- Statutory limit: INR 300,000
Monthly salary: INR 51,800 (Salary plus dearness allowance forming part of retirement benefit, i.e. 50,000 + 1,800 (3000*60%))
10 months’ salary: 518,000
10 months’ average salary: INR 518,000/10 = INR 51,800 i.e. February 2012 – November 2012 (Before retirement), including Dearness Allowance of INR 1,800 per month)
Leaves due = Leaves allowed – Leaves taken
30 days per year allowed * 20 years = 600 leaves
Therefore, leaves due = 600-480 = 120 leaves
Average salary for 10 months will be 518,000/10 months = INR 51,800
(121 days/ 30 days) * (51,800) = INR 207,200
- Exempt leave encashment = INR 207,200
Other points of consideration regarding tax on leave encashment
- Average salary is to be calculated on the basis of salary drawn during the period of 10 months preceding retirement
- Salary includes Dearness Allowance (DA) forming part of retirement benefits. It also includes commission based on fixed percentage of turnover achieved by the employee. However, any other type of allowance received as part of salary is not to be included in the computation of salary for the purpose of leave encashment
- The statutory limit of INR 300,000 for non-government employees is an aggregate sum applicable across employers. If the employee has received leave encashment in any one or more earlier previous years’ also and had availed of the exemption in respect of such amount, the statutory limit of INR 300,000 shall be reduced by the amount of exemption availed earlier.
Illustration: In April 2004, Mr. Akhilesh retired from HDFC Ltd. and received leave encashment of INR 84,000. Entire amount was qualified for exemption. After his retirement from HDFC Ltd. he joined Punjab National Bank in March 2013, he retired from Punjab National Bank and received leave encashment of INR 2,00,000. In this case, the maximum amount of exemption in respect of leave encashment received from Punjab National Bank will be limited to INR 2,16,000 (INR 3,00,000 less INR 84,000 claimed earlier).
- Leave encashment received by the family members after the death of the employee is not chargeable to tax in the hands of the family member
- The retirement of employees may be of various kinds such as superannuation or voluntary retirement such as resignation. This section applies equally to a case of voluntary retirement on account of resignation.