Enhanced Tax Exemption on Leave Encashment: Non-Government Salaried Employees in FY 2023-24

Introduction

The Finance Ministry recently announced a significant increase in the tax exemption limit for leave encashment on retirement for non-government salaried personnel. The limit has been raised from ₹3 lakh to ₹25 lakh, effective from April 1st, 2023. This change aims to provide substantial financial benefits to private sector employees who retire or superannuate on or after April 1st, 2023.

What is Leave Encashment

Leave encashment refers to the practice of compensating employees for their unused paid leave days, such as vacation or sick leave, instead of taking time off from work. In other words, employees have the option to receive financial remuneration for the leave days they have accumulated but did not utilize.

Process of Leave Encashment

• Leave encashment is a benefit provided to employees where they can convert their unused or unavailed leaves into cash.
• It is applicable to both government and private sector salaried employees.
• Leaves that are not utilized by the employee within a specific period can be carried forward to subsequent years.
• Employees can request leave encashment for the accumulated leaves that they haven't used.
• The amount to be paid for leave encashment is calculated based on the employee's salary and the number of unused leaves.
• Leave encashment may be subject to income tax deductions as per the regulations of the income tax department.
• The encashed amount is typically added to the employee's salary and paid out through the regular payroll system.
• Leave encashment is an additional benefit provided by the employer in addition to other incentives, allowances.
• The encashed amount can be utilized by the employee for personal purposes or saved for future needs.

Exemption Applicable for Leave Encashment

Under section 10(10AA) of the Income Tax Act, 1961, the tax exemption for leave encashment is determined by specific circumstances:

1. Encashing Leaves while on Payroll or Termination (Other than Retirement)

• In such cases, no exemption is applicable.
• The entire amount received is fully taxable for all employees, including those in government and private sectors.
• It is important to note that relief under section 89 is available in such situations.

2. Leave Encashment at the Time of Retirement

a. Government Employees:
At the time of retirement, the Leave salary received is fully exempt from tax.

b. Private Employees:

Leave salary received at the time of retirement is exempt from tax up to the least of the following:

1. ₹25,00,000 (previously ₹3 lakh)
2. Actual leave encashment received
3. Average salary of the last 10 months multiplied by 10

- Cash equivalent of unutilized leave (unutilized leave in months multiplied by average salary of the last 10 months)

Benefits of the Revised Tax Approach

The revised tax approach brings significant benefits to salaried individuals, with approximately 50% of personal income taxpayers falling under this category. Regardless of whether individuals choose the new or old tax regime, they will now enjoy a larger leave encashment exemption at the time of retirement.

Background and Impact

The previous tax exemption limit of ₹3 lakh for leave encashment was set in 2002 when the highest basic wage in the government sector was ₹30,000 per month. Recognizing the need for an updated and more suitable exemption, the limit has now been raised to ₹25 lakh to align with evolving economic circumstances.

Conclusion

The enhanced tax exemption on leave encashment is a significant development that empowers non-government salaried employees to enjoy substantial financial benefits during retirement. Employers are likely to restructure their emoluments structure to incorporate this benefit, enabling employees to achieve greater tax savings upon retirement. The estimated savings of ₹7 lakh in taxes further emphasize the positive impact of this tax exemption hike.

Date of Notification

The notification for the increased tax exemption limit on leave encashment for non-government salaried employees was issued on May 24th, 2023, and it is effective for the financial year 2023-24.