Explainer: Are you a salaried person? Know how leave encashment is taxed

Comments by CA Manish P. Hinger, Founder of Fintu

As per the labor law every salaried person is entitled to a minimum number of paid leave every year. However, it is not necessary that an individual employee utilizes all the leave entitled for one year. In fact, most employers give employees the option to carry forward such unused paid leave. This would leave an accumulated unutilized leave left with the employee at the time of retirement or resignation from the company, as the case may be. This forces the employer to compensate the employees for unused paid leave. Let us understand the tax implications of leave encashment:

taxation of leave encashment

Encashment of leave received during service

1. Accumulated leave can be encashed either during service or at the time of retirement or resignation.

2. Any leave availed during service is fully taxable and forms part of ‘Income from Salary’. However, relief can be claimed under section 89.

Encashment of leave at the time of retirement or resignation

Leave encashment received at the time of retirement or resignation is either fully or partially exempt depending on the category to which the employee belongs. This is explained in more detail below:

1. Leave encashment received by Central or State Government employees at the time of retirement or resignation is fully exempt.

2. Leave encashment received by legal heirs of deceased employees is fully exempt.

3. Leave encashment availed by non-Govt. employees is exempt on the basis of calculation 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:

The salary for this purpose includes basic pay, dearness allowance and commission based on a certain percentage of the turnover secured by the employee. specified amount of The total amount allowed as exemption by different employers irrespective of the frequency of leave encashment received by the employees is 3,00,000. If an employee has used 2,00,000 already at the time of first resignation, he was only . is entitled to use the balance amount of 1,00,000 for computing the discount next time. Therefore, only total exemption is allowed to a composite employee. 3,00,000 in respect of leave encashed from all employers.

Let us understand exemption with an illustration.

• Mr. A is retiring after 15.5 years of service.

• Mr. A was entitled to 35 days of paid leave per year from his employer, i.e., a total of 542 days of leave during his entire service.

• Out of this Mr. A has already utilized 200 days of paid leave and has 342 days of unutilized leave left.

• Was getting basic salary + DA of Mr. A 33,000 per month at the time of retirement and received 3,76,750 calculated on the basis of 342 days as leave encashment * Rs. 1,100 (salary per day = 33,000/30 days).

Comments by Dr. Suresh Surana, Founder, RSM India

Leave encashment refers to any cash received by the employees towards unutilized/credited leaves both during the tenure of their service as well as at the time of retirement. Leave encashment received by the Government employees at the time of retirement/ superannuation would be exempt from tax u/s 10(10AA) of the Income-Tax Act (hereinafter referred to as IT Act). On the other hand, employees other than Government employees receiving Leave Encashment may also avail tax exemption of section 10(10AA) of IT Act to an extent of lower of the following-

i. Actual Amount Received; or

ii. Rs.3,00,000; or

iii. 10 months Average salary; or

iv. Unavailed Leaves*Average salary

It is pertinent to note that any leave encashment received during the tenure of service or period shall be taxable for all employees.

For the purpose of the above computation, Average salary would mean average of 10 months’ salary preceding the date of retirement and Salary would constitute Basic salary, Dearness allowance (in terms) and Commission based on a fixed percentage of turnover secured by an employee.

Leave Credit would mean Leaves Allowed reduced by Leaves Availed. IT Act Allows 30 Leaves for each completed year of service.

Comments by Sandeep Setty, Vice President of HR, Pazcare

Leave encashment is simply the amount of money obtained in exchange for the period of leaves not availed by an employee. In my previous experience, earned leave encashment was calculated based on basic salary, and was encashed during employee exit only. However, there are companies that calculate it based on gross salary.

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