Taxes on Leave Encashment

Normally every employee is entitled to certain number of leaves per month/annum. If this leave is not availed then unutilized leave either get lapsed or get carry forward and at the time of retirement/otherwise or on leaving the employer, pay equivalent to leave remaining unutilized in the employee account will be paid to employee.

Now, the question arise that “Leave Salary is Taxable or not”? For this you should know the income tax treatment of Leave Salary as per Income Tax Act, 1961. The income tax treatment depends on two things:

• Status of Employee – Government employee or Non government employee.
• Nature of Leave Encashment – Leave are encashed mainly on two occasions: Leave encashment during Continuity of employment or Leave encashment at the time of retirement / leaving job.

You get some amount in return whatever the reason for encashing the leaves and consequently, there are income tax implications for this amount. Thus, Taxability of Leave Salary for following type of employee is given below:

Government Employee – Government employee means an employee of the central or state government. It does not include employees of local authorities or bodies like municipal corporations or panchayats.

1. Leave Encashed during the continuation of service – Amount received from Leave encashment during the continuation of service is added to your income, and is fully taxable.

2. Leave encashed at the time of retirement or superannuation (leaving the job) – Amount received from Leave encashment at the time of retirement or superannuation (leaving the job) is fully exempt from tax under Section 10(10AA)(i) of the Income Tax Act,1961.

Non – Government Employee – Non – Government Employee means employee other then Government employee.

1. Leave Encashed during the continuation of service – Amount received from Leave encashment during the continuation of service is added to your income, and is fully taxable.
2. Leave encashed at the time of retirement or superannuation (leaving the job) – Exemption of amount received from Leave encashment at the time of retirement or superannuation (leaving the job) is limited to the least of the following:

a) The amount actually received from leave encashment
b) The cash equivalent of leaves available in your account (leave balance) (not exceeding 30 days per year of actual service)
c) Last 10 months’ average salary
d) Amount specified by the Government i.e., Rs. 3 Lakhs
Other points to be kept in mind

• The limit on exemption is applied on the total payment received towards leave encashment from two or more employers, in the same year or in different years.

• Salary means last drawn salary and includes basic salary + Dearness Allowance (if terms of employment so provide) + Commission based on a fixed % of turnover.

• Cash equivalent of leaves can be calculated on maximum allowable leave per year which is 30 days i.e., even if your company allows, say, 50 days of encashable leaves every year, you need to count only 30 days per year.

• Average Salary is calculated on the basis of average salary for the 10 months immediately preceding the retirement or superannuation.