Leave Encashment, their Exemption and Tax liability

Introduction -

During the service tenure, you are allowed various types of leaves e.g. Sick leave, Casual Leave, Earned Leave, etc.

• Sick leave and casual leaves cannot be carried forward to next years.
• Earned leaves can be accumulated and carried forward to next years.

Some time the employees can not avail all these earned leaves which were allowed to him. He may encash these leaves and earn salary for the number of days which were allowed to be taken as leaves. The number of leaves allowed to be taken and the leave encashment varies from employer to employer policies. An employee can avail leave encashment under the following events-

• During the continuation of service.
• At the time of retirement or superannuation or resignation.

Tax liability and exemption under section 10 (10AA)-

1. Leave encashment during the continuation of service is always taxable. No exemption is allowed.
2. Leave encashment received by his family members after the death of employee is not taxable in the hands of family members.

At the time of retirement or superannuation or resignation.

For Govt. Employees-

Leave encashment at the time of retirement or superannuation or otherwise received by a Govt. employee, is fully exempted. No tax would be levied on that amount.

For Example:

Mr. X is a government employee  and he is entitled to 30 days leave per year. His outstanding earned leaves are 350. He received Rs. 5,00,000 on account of leave encashment at the time of retirement. What is the tax liability?

Answer:

Mr. X is a Government employee and amount received of Rs. 5,00,000 on his retirement is fully tax free.

For other Employees-

Leave encashment at the time of retirement or superannuation or otherwise received by any other employee, is exempt to the extent of certain limit. Least of the following is exempt from tax-

1. Leave Encashment actually received.
2. 10 months average salary
3. Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of completed service.
4. Rs. 3,00,000

However, please note the below:

1. Salary means Basic Salary+ Dearness Allowance + Commission if paid on percentage of sale.
2. Average Salary means salary earned by an employee immediately preceding 10 months from the date of retirement.
3. Unavailed leave calculated on the basis of maximum 30 days leave for every year of completed services. If employer allowed entitling for leave encashment of 40 days, leave calculated on the basis of maximum 30 days or if employer allowed entitling for leave encashment of 25 days leave calculated on the basis of 25 days.
4. If an employee receives leave encashment from more than one employer, the quantum of exemption will be computed independently in respect of each employer.
5. The total amount of exemption should not exceed Rs.3, 00,000/- during his lifetime.

For Example:

Mr. X is a Non Government employee and he is entitled to 40 days leave per year. He availed 600 days leave during his service tenure. He rendered 30 years 7 months in an organization. At the time of retirement his Basic Salary was Rs. 50,000 and Dearness Allowance was Rs. 20,000 from the past 10 months. He received Rs. 5,00,000 on account of leave encashment at the time -of retirement. What is the tax liability?

Answer-

1. Leave encashment actually received i.e. Rs. 5,00,000

2. 10 months average salary @ (50,000+20,000) i.e. 70,000 PM x 10 months = 7,00,000

3. Cash equivalent of unavailed leave on the basis of 30 days leave for every completed year of service = 30 days x 30 years = 900

Less: Already availed = 600
Balance unavailed leave = 300 i.e. 10 months
Amount comes to Rs. = 10 months * 70,000 per month = 7,00,000

4. Rs. 3,00,000

Exempted amount is least of the above i.e. 3,00,000
Tax implication on leave encashment - Amount actually received = 5,00,000
Less: Exempt under section 10(10AA) = 3,00,000
Balance Taxable Amount = Rs. 2,00,000