Non-Government Employees gets IT exemptions for leave encashment hiked

In a recent development aligned with the budget proposal for 2023, the finance ministry has announced an enhanced ceiling for the encashment of earned leave exempt from income tax. The notification, dated May 24, 2023, will come into effect from April 1, 2023.

The finance ministry, exercising its powers conferred by sub-clause (ii) of clause (10AA) of section 10 of the Income-tax Act, 1961, has specified the new limit of Rs. 25,00,000 (twenty-five lakh rupees) in relation to employees who retire, whether on superannuation or otherwise. This revised limit applies to the maximum amount receivable by employees as cash equivalent of leave salary for the period of earned leave at their credit upon retirement. The circular states that this notification is deemed to have come into force from April 1, 2023.

This update brings positive news for non-government employees, as they will now enjoy increased tax exemptions for leave encashment against their accumulated leave balances over time. In her Budget speech, Finance Minister Nirmala Sitharaman highlighted the need to adjust the existing limit, which had been set at Rs. 3 lakh for tax exemption on leave encashment since 2002. This limit was established when the highest basic pay in the government was Rs. 30,000 per month. Considering the subsequent increase in government salaries, the finance minister proposed raising the limit to Rs. 25 lakh.

Leave encashment, which refers to the payment received for unused leave upon retirement or resignation, is considered as "Income from Salary" for employees in the private sector. However, under Section 10 (10AA)(ii) of the Income-tax Act, they can claim an exemption for such payments.

To determine the tax exemption for non-government employees, the least of the following amounts, as outlined in Section 10 (10AA)(ii), will be considered:
1. Period of earned leave in months (*) × Average monthly salary (**)
2. Average monthly salary (**) × 10 (i.e., 10 months' average salary)
3. Maximum amount specified by the Central Government, currently set at Rs. 25,00,000. Different ceiling limits are specified by the government for different years.
4. Leave encashment actually received at the time of retirement.

Previously, the maximum exemption limit for non-government employees was capped at Rs. 3 lakh. However, with the new notification, the ceiling has been significantly increased to Rs. 25 lakh.

This revision in tax exemptions for leave encashment recognizes the evolving salary structures and ensures that non-government employees receive fair treatment. It not only aligns with the increased salaries in the government sector but also provides relief to individuals by reducing their tax liabilities. As a result, non-government employees can now leverage this update to maximize their tax savings and enhance their financial well-being upon retirement or resignation.