Taxability of Leave Encashment / Leave Salary
Leave Salary or Leave Encasement means the amount receives by the employee against the leaves he was given but he has not utilized.
The taxability of the leave encashment amount comes under the ambit of section 10(10AA), which depends upon the fulfillment of certain conditions given under the income tax act. Let’s dig this section deeper:
Leave encashment on resignation is not taxable
According to section 10(10AA) of the Income Tax Act the tax treatment on leave encashment amount received by employee depend upon the following two situations:
- Leave encashment while being employed in the company
While in service leave salary is fully taxable in the hands of employee under Section 17(1)(va), irrespective of the sector the employee is employed with i.e. Government Sector or Private sector.
- Leave encashment when employee is leaving the organization:
- For a Government Employee: The entire amount of leave encashment is tax-free for government employee (central or state)under Section 10(10AA)(i)
- For a Private Sector Employee: Leave encashment is partly exempted (under Section10(10AA) up to the least of the following:
- Leave encashment actually received at the time of retirement.
- Standard Limit of Rs. 3,00,000/-
- Ten months’ average salary from the date of retirement;
- Cash equivalent of 30 days average salary for every completed year of service as reduced by actual leave availed or encashed during the tenure of service.
- The period of 30 days is the maximum ceiling. If employer allows leave for less than 30 days p.a. then such lesser days shall be considered.
- Average salary means Basic + DA (forming part of retirement benefit) + Commission (as a fixed percentage on turnover) being last 10 months average salary from the date of retirement.
- While calculating completed year of service, ignore any fraction of the year.
- While claiming the statutory amount (i.e. Rs.300000) any deduction claimed earlier as leave encashment shall be reduced from Rs.300000 Assessee can claim Relief u/s 89(1).
Calculation of Leave Encashment:
[gview file=”http://www.indiantaxupdates.com/downloads/leave_encashment_calculator_by_indiantaxupdates.com.xls” save=”1″]
Is the Leave encashment exempt only on retirement or also on resignation?
Section 10(10AA) clearly states, “on retirement or otherwise“; the key word here is ‘otherwise’, which suggest there are certain exemptions in the case of a person leaving his job for reasons other than retirement.
It is, therefore, clear that if on retirement, even on resignation by the employee, an employee gets by way of leave encashment any amount, Sec. 10(10AA) would apply and the assessee will be entitled to the benefit of the said clause to the extent mentioned therein.
Tax on Leave Encashment / salary paid to the legal heir
Leave salary paid to the legal heir of deceased employee is not taxable as salary. The Act is silent on treatment of leave encashment received after death of employee. However, on following grounds, it can be concluded that leave salary received by a legal heir shall not be taxable in the hands of the recipient.
a) A lump sum payment made gratuitously to widow or legal heir of employee, who dies while in service, by way of compensation or otherwise is not taxable under the head ‘Salaries’. [Circular No.573, Dated 21.08.1990]
b) Unutilized deposit under the capital gains deposit account scheme shall not be taxable in the hands of legal heir. [Circular No.743 dated 6/5/1996 ]
c) Legal representative is not liable for payment of tax on income that has not accrued to the deceased till his death.
d) Leave salary paid to the legal heir of deceased employee is not taxable as salary. [Circulars Letter No. F.35/1/65-IT(B), dated 5/11/19 65 ]. Further, leave salary by a legal heir of the Government employee who died in harness is not taxable in the hands of the recipient [Circulars No.309, dated 3/7/1981 ].
Conclusion: If leave salary becomes due before the death of the assessee (no matter when and by whom received), it shall be taxable in the hands of employee. Whereas if such salary becomes due after the death of assessee, it shall not be taxable (even in the hands of legal heir of the assessee).