Tax on Leave Encashment
Introduction
Leave encashment during employment is fully taxable. However, leave encashment at retirement or upon the employee’s death is exempt up to Rs. 25,00,000.
Taxability of Leave Encashment
- Death of Employee
- Leave encashment paid to legal heirs is exempt from tax as it is not considered a payment to the employee. [Circular No. F.35/1/65-17(B), dated November 5, 1965 and Circular No. 309, dated July 3, 1981]
- Government Employees
- Fully exempt on retirement.
- Fully taxable if encashed during employment.
- Non-Government Employees
- Fully taxable if encashed during employment.
- Partially exempt on retirement subject to the lower of:
- Actual leave encashment received.
- 25,00,000. [Notification No. 31/2023, dated 24-05-2023, is effective from 01-04-2023]
- Cash equivalent of unavailed leave calculated on the basis of average salary for up to 30 days per completed year of service.
- Average salary of the last 10 months.
- Relief for Tax on Arrears
- Relief under Section 89 is available for leave encashment received during employment. [Circular No. 431, dated September 12, 1985]
Key Calculations
- Average Salary
- Includes basic salary, dearness allowance (if part of retirement benefits), and commission based on turnover.
- Unavailed Leave Calculation
- Formula:
Step 1: Calculate number of completed years of service (ignore any fraction of year).
Step 2: Calculate earned leave entitlement for each year of service assuming that earned leave entitlements can’t exceed 30 days for every year of actual service.
Step 3: Calculate earned leave actually taken or already encashed (in number of days) during the service time.
- Step 4: Unavailed Leaves (In Months) = [(Step 1 * Step 2) minus Step 3]/30
- Leave from Multiple Employers
- Maximum exemption of 25,00,000 applies across all employers and years.