Income Tax on Leave Salary

The basic knowledge

An employee is allowed various types of leaves like Casual Levees, Earned Leaves, Medical Leave, Gazetted Holidays, etc. Generally, the employee is allowed to either avail of these leaves or carryforward to next year. Sometimes, the employee is also allowed to encash these unutilized leaves and can earn a salary against them.

The leave encashment depends on the leave encashment policy which may be different with each employer. The leave encashment policy decides how many leaves are allowed to encash and what will be the salary against them.

That’s why Employees are keen to carry forward leaves and use them for encashment. It’s a great source of income for them.

Tax on Leave Encashment

The amount of leave encashment would be liable to tax under the head “Income from Salary”

However, Assessee can claim exemption from the amount received as leave encashment and the balance amount would be taxable as per the Income Tax Slab Rates. The computation of taxable leave salary would be as under:-

Computation of Exempted amount of Leave Encashment

A. Encashment of leave during tenure of service:

Leave encashment during the tenure of service with the same employer is fully taxable and no exemption is allowed.

B. Encashment of leave salary at the time of retirement

Section 10(10AA) deals with the exemption amount of leave salary received to the employee. Under section 10(10AA), the employees are divided into two types of categories:

1. Govt Employees(Central Govt and State Govt) :

Amount received towards Leave encashment of accumulated leave at the time of retirement, whether on superannuation or otherwise, is fully exempt from tax. Means no tax liability on any amount received as leave encashment by govt employees on retirement.

2. Other Employees:

The exemption is allowed to other employees from the amount received towards Leave encashment at the time of retirement (whether on superannuation or otherwise). In such a case, the lowest of the following shall be exempted: –

1. 1. Leave encashment actually received
   2. 10 months “average salary”
   3. Cash equivalent of unveiled leave (Maximum 30 days leave X Completed Year of service).
   4. Maximum Amount as specified by the Govt i.e. Rs. 3,00,000

Key elements of Tax on Leave Encashment

1. “Salary” for the above purpose means “Basic + Dearness Allowance” including commission received if any based on a fixed percentage of turnover.
2. “Average Salary” means the average salary drawn by the employee during the period of 10 months immediately preceding his retirement.
3. Leave Encashment Received in Earlier Years: The maximum limit of Rs 3,00,000 is available for complete years of service. This means If the employee has availed the exemption of leave encashment received from any one or more employers, then the limit of Rs. 3,00,000 specified above shall be reduced by the amount of exemption availed earlier.
4. Leave encashment received by the family members: Leave encashment received after the death of an employee is not chargeable to tax in the hands of the family member.
5. Resignation: Resignation is also treated as retirement. This section applies equally to a case of voluntary retirement on account of resignation. The amount received as Leave Encashment on Resignation by an employee would be treated in the same manner as the amount received on Retirement.
6. Relief Sec 89: Employees in service can claim relief under section 89 of the Income Tax Act.