Every salaried person as per labour law is entitled to a minimum number of paid leave every year. However, it is not necessary that an individual employee utilises all the leave he is entitled for a year. In fact, most employers allow the employees an option of carrying forward such unutilised paid leaves.
This would invariably leave the employee with an accumulated unutilised leave balance at the time of retirement or resignation from the company as the case may be. This compels the employer to compensate the unutilised paid leave of the employees. This concept is better known as leave encashment.
Taxation of Leave Encashment
Leave encashment received during service
Accumulated leave can either be encashed during service or at the time of retirement or resignation. Any leave encashed during service is fully taxable and forms part of ‘income from Salary’. However, relief under Section 89 can be claimed.
Leave encashed at the time of retirement or resignation
Leave encashment received at the time of either retirement or resignation is either fully or partially exempt depending upon the category that an employee falls under. This has been elaborated further below:
- Leave encashment received by Central or State Government employee at the time of retirement or resignation is fully exempt
- Leave encashment received by legal heirs of deceased employee is fully exempt
- Leave encashment received by Non-Government employee is exempt based on the computation provided under Section 10(10AA)(ii) and balance amount if any is taxable as ‘income from salary’
Formula for computing leave encashment exemption of Non-government employees
|
Particulars |
Amount |
|
|
Leave encashment received (A) |
XXXXX |
|
|
Less: Exemption under Section 10(10AA) –(B) Least of the following: a. Amount notified by the Government** Rs 3,00,000 b. Actual leave encashment amount c. Average salary* of last 10 months d. Salary per day * unutilised leave (considering maximum 30 days leave per year) for every year of completed service (F) |
XXXX |
|
|
Leave encashment taxable - (A) - (B) |
XXXX |
*Salary for this purpose includes basic salary, dearness allowance and commission based on fixed percentage of turnover secured by employee
** Specified amount of Rs 3,00,000 is the aggregate amount allowed as exemption irrespective of frequency of leave encashment received by employees by various employers. If an employee has utilised Rs 2,00,000 already at the time of first resignation, he is only entitled to use the balance of Rs 1,00,000 for the exemption computation next time. Hence, an overall employee is allowed total exemption of only Rs 3,00,000 with respect to leave encashed from all employers.
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