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Tax Treatment of Leave Encashment Salary

1. In the case of continuity of services. Government/Non-Government employee - Leave encashment during Continuity of employment - It is chargeable to tax. However relief can be taken under section 89 -As per Income Tax Act, 1961 u/s 10(10AA)

CA Yogesh Sarawgi

Is leave encashment fully taxable?

(i) Leave Encashment during service is fully taxable in all cases, relief u/s 89 if applicable may be claimed for the same.

(ii) Any payment by way of leave encashment received by Central & State Govt. employees at the time of retirement in respect of the period of earned leave at credit is fully exempt.

(iii) In case of other employees, the exemption is to be limited to the least of following:

(a) Cash equivalent of unutilized earned leave (earned leave entitlement can not exceed 30 days for every year of actual service)

(b) 10 months average salary

(c) Leave encashment actually received. This is further subject to a limit of Rs 3,00,000 for retirements after 02.04.1998.

(iv) Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of death is not taxable.

Let us understand the above Provisions in a systematic manner –

1. In the case of continuity of services.

Government/Non-Government employee Leave encashment during Continuity of employment It is chargeable to tax. However relief can be taken under section 89

As per Income Tax Act, 1961 u/s 10(10AA)

2. Leave encashment at the time of retirement / leaving job

Government employee Leave encashment at the time of retirement / leaving job It is fully exempt from tax under section 10(10AA)(i)
Non-Government employee 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)

Second being accumulated leaves enchased by a non govt. employee on his/ her retirement whereof the complicated part of calculation of exempted leave salary is calculated as LEAST of the following:

1. Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of actual service rendered.
2. 10 × Average monthly salary.
3. The amount specified by the Government  i.e., Rs. 3,00,000 /-;
4. Leave encashment actually received at the time of retirement.

How to find out Average monthly salary?

Salary, for this purpose, means basic salary and includes dearness Allowance if terms of employment so provide. It also includes commission based upon fixed percentage of turnover achieved by an employee, (if any). ‘Average Salary’ for the aforesaid purpose is to be calculated on the basis of average salary drawn during the period of 10 months ending on the date of retirement.

Leave encashment taxable amount = Actual encashment received – Exempted u/s 10(10AA) given above

(Republished with amendments)

Categories: Income Tax

View Comments (10)

  • will the legal next to kin have to pay tax on the leave salary if the original assessee expires?

  • i received an amount of Rs.1500000 as leave salary after my retirement.My average 10 months salary prior to retirement is more than 1200000.may i show taxable income as Rs.1200000 and tax exemption as Rs.300000 in income tax return.

  • Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of death is not taxable. Is there any case laws ?

  • I am employee. My deptt. Was govt. Deptt. Prior to 2009. Later on it convert in limited utility. I.e. Himachal Pradesh electricity Board to Himachal Pradesh electricity board limited. Will I get benefit of tax exemption of leave encashment at the time of retirement. As I have 300 days earned leave in my account when my deptt. Convert govt. Deptt. To limited utility.

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