Leave Encashment – Tax Treatment for Government & Private Sector Employees

Employees in service are allowed different types of leaves such as official holidays, medical leaves, casual leaves etc. Many employees may not utilize all the leaves and it remains unutilized at the end of the year.

There are some types of unutilized leaves can be carried forward to the next year whereas some types of leaves lapse at the end of the year.

Most of the time, employees have the option to encash their unutilized leaves at the end of the financial year or he can carry forward it to the next year. Many employees encash their accumulated leaves of the service period at the time of retirement.

How to Calculate Leave Encashment

The policy of different types of leaves and the encashment is depended upon the employer. The leave encashment amount is equal to salary of unutilized paid leaves days (No. of unutilized leaves X Salary Per Day). Generally, Basic Salary and Dearness Allowance are considered for the calculation of leave encashment.

Tax Treatment of Leave Encashment for Government Employees (Central & State Govt.)

  1. Leave Encashment during the Tenure of Service – Fully Taxable
  2. Leave Encashment at the time of Retirement/TerminationFully Exempt [Section 10(10AA)]
  3. Leave Encashment after the Death of Employee – Fully Exempt (CBDT Circular 309 dated 03.07.1981)

Tax Treatment of Leave Encashment for Non-Government Employees (Private Sector)

During ServiceTaxable
At RetirementExempt Equal to Below Calculation
Death of EmployeeExempt

Calculation of Exemption of Leave Encashment at Retirement (for Non-Government Employees) – Section 10(10AA) of Income Tax Act

Least of following is exempted and the rest amount of leave encashment will be taxable:

1) Actual Receipt (leave encashment)

2) 3,00,000

3) Average Monthly Salary X 10

4) Leave Unavailed X Average salary

Explanations:

1. Meaning of Leave Unavailed

  • Leave Unavailed = Total Leave Minus Leave Availed
  • Total Leave = Leave Per Year Allowed by Employer (Maximum 30 leaves per year) X Period of Service

2. Average Salary = Average of the salary of 10 months immediately preceding the retirement/superannuation/termination. For example, if the employee retires on 16 November, the average of salary of 17th January to 16th November shall be computed.

3. Meaning of Salary = Basic Salary + FDA/FDP + Commission on Sale Per Year

4. Where leave encashment is received from two or more employers during the same year, the total exemption will not exceed Rs. 300000/-

5. Where the assessee has claimed exemption in respect of leave encashment in an earlier year and subsequently there is again receipt of leave encashment, the limit of Rs 3,00,000/- will be reduced by the amount of exemption claimed in the earlier year

Example:

Rahul is a non-government employee who receives leave encashment of Rs. 5 Lakh for (500 Days of unutilized leaves) at the time of retirement. The service period of Rahul was 20 Years and he was eligible for 40 paid leaves. His Average monthly salary was Rs. 25000. Now the calculation of exemption will be as follows:

  1. Actual Receipt = Rs. 500000
  2. Maximum Cap = 3,00,000
  3. Salary of Last 10 months = 250000
  4. Leave Unavailed X Average Salary = 250000*

*[Total Leave Max. 30 Per Year (30X20) minus  Leave Availed (800-500)] X Average Daily Salary (833)

So the Exemption will be least of above = 250000 and taxable amount is 250000 [i.e. 500000-250000]

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