The policy of a company enables its employees to apply for different types of leave, based on their requirements, eg., annual leave, sick leave, casual leave, etc. Sometimes, employees are unable to use their leave balance due to their busy work schedules and have unused balance lying to their credit.
What is leave encashment? Accumulated leave standing to the credit of employees at the end of the year may be carried forward. It could also lapse based on the company’s policy.
Generally companies want employees to avail their leave balance. However, there are some companies which forfeit the leave also. There are companies that pay an amount computed on the basis of leave standing to the credit of the employee annually or allow accumulation with an upper limit and, thereafter, pay on retirement or resignation. Encashing the leave balance is known as leave encashment.
Taxability of leave encashment while in service: Leave encashment received while in employment is fully taxable in the hands of the employee. If an employer is making payment of the leave balance, the cash value received would be taxable in the respective financial year at the normal tax rates.
Taxability of leave encashment after retirement: The Income-tax Act, 1961 (IT Act) provides an exemption if the money is received on retirement for non-government employees. As per Section 10(10AA) of the IT Act, leave encashment is exempt to the extent of the lower of the following: Amount actually received from the employer as leave encashment; or cash equivalent of leave (to be calculated on the basis of a maximum of 30 days of leave per year); or 10 months’ average salary (salary refers to the last drawn basic salary, dearness allowance and commission based on a fixed percentage of turnover); or the amount prescribed by the government of India, ie., R3 lakh. Any leave encashment for central/state government employees in respect of the earned leave is exempt from tax.
Taxability of leave encashment on resignation: As per the IT Act, the provisions applicable to retirement will similarly apply to resignation. It uses the words ‘at the time of his retirement whether on superannuation or otherwise’ and, based on judicial precedents, the word otherwise can be interpreted to include resignation. Hence, you can take the benefit of tax exemption if you have resigned and you are entitled to leave encashment.
Taxability of any subsequent leave encashment received from other employers: