Leave Encashment: Tax Computation of Amount Exempted

While an employee is in service, he is allowed various types of leaves like Medical Leave, Gazetted Holidays, Casual Leaves etc. There are some types of leaves which can be carried forward to the next year whereas there are some leaves which cannot be carried forward to the next year.

In case an employee does not avail all the leaves which were allowed to him, he may also encash these leaves and earns salary for the no. of the days which were allowed to be taken as leaves but were not availed as leave. The policy of no. of leaves allowed to be taken and the leave encashment depends on the employer for whom you are working and different employers have different policies for leave encashment.

Tax on Leave Encashment

In case you have not taken leaves and have opted for encashing these leaves, your employer would be paying you some amount as leave encashment. The amount so received on account of encashing the leaves not availed would be liable to tax under head “Income from Salary”.

However, at the time of filing of income tax return, certain exemptions would be allowed from the amount received as leave encashment and the balance amount would be taxable as per the Income Tax Slab Rates in force for that year. The manner of computation would be as under:-

Computation of Amt Exempted from Leave Encashment

Encashment of leave during tenure of service: Leave encashment to an employee, while he continues to be in service with the same employer is fully taxable and no exemption is allowed.

Encashment of leave salary at the time of retirement

Exemption from amount received as leave salary is available under Section 10(10AA). For the purpose of availing exemption under  section 10(10AA), the employees are divided into 2 types of categories:-

1. Govt Employees (Central Govt and State Govt employees only): Leave encashment of accumulated leave at the time of retirement, whether on superannuation or otherwise, received by a Govt employee, is fully exempt from tax. No tax would be levied on any amount received as leave encashment by govt employees on retirement.
2. Other Employees: Leave encashment of accumulated leave at the time of retirement whether on superannuation or otherwise received by any other employee (except those covered above) is exempt from tax to a certain limit. In such a case, the least of the following shall be exempted:-
   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. Amount specified by the Govt i.e. Rs. 3,00,000

Relevant Points regarding Tax on Leave Encashment

1. Salary for the purpose of above computation means “Basic + Dearness Allowance”. It also includes commission based on fixed percentage of turnover achieved by the employee. However, any other allowance received is not to be included in the computation of Salary.
2. Average Salary is to be computed on the basis of the average salary drawn by the employee during the period of 10 months immediately preceding his retirement.
3. If the employee has received leave encashment in any one or more earlier previous year(s) also and had availed of the exemption in respect of such amount, the limit of Rs. 3,00,000 specified above shall be reduced by the amount of exemption availed earlier.
4. Leave encashment received by the family members after the death of an employee is not chargeable to tax in the hands of the family member.
5. The retirement of employee may be of various kinds. It may be on superannuation or voluntary such as resignation. This section applies equally to a case of voluntary retirement on account of resignation.
6. Amount received as Leave Encashment on Resignation by an employee would be treated in the same manner as the amount received on Retirement. Therefore, tax would be levied on the amount received on Leave Encashment in the same manner as amt received on Resignation.