You know why the question of the tax on leave salary encashment arises.
Almost all the companies provide certain days of leave with pay to their employees. In India, labour law provided provision in this regard. This leave will provide every year. If the employee wishes to enjoy it, they can use it. But in most cases, the employees will accumulate these leave days and encash from the company. So here we try to answer this question as per the Income Tax Act in India.
Leave salary encashment is the payment by most of the companies to employees for the accumulated leave.
Table of Contents
Taxability of Leave Salary Encashment
Leave Salary encashment is taxable as per the Income Tax Act, 1961, based on many factors, like termination of employment, nature of the employer and the statutory limit of a maximum of INR 300000.
Taxable leave encashment
Employees normally receive the leave salary encashment in three different stages
(a) The employee received the leave Salary encashment during the continuation of services
(b) Employees received the leave encashment at the time of retirement or termination of employment
(c) Leave Enchant Salary paid to the legal heirs of the employee
Tax Treatment of Leave Encashment Salary
If an employee receives the leave salary during the continuation of the service, this leave salary is fully taxable irrespective of Government employee or not. However, leave salary received at the time of termination of the service, is fully exempted in case of central and state government employees.
In the case of Non-Government employees, their leave salary received the time of termination is taxable after some exemptions.
(A) Fully Taxable Leave encashment Salary
Mr Rajesh’s employer provides one month leave for every completed year of service. He has not used these leaves. Now he has completed 10 years of service, Mr Rajesh has 10 months of leave balance in his credit.
Suppose he encashed his leave salary during the continuation of the service.
In this case, as per the Income Tax Act, Mr Rajesh’s leave salary encashment is fully taxable. It will not consider the nature of the organization where he works. It may be government or private or public company, but no matter in this case.
Leave salary received by employees when they are in service is fully taxable.
(B) Fully exempted Leave encashment salary
When the leave encashment salary fully exempt?
Mr B is working as a Central Government employee and Mr C is a state government employee. Both of them have balance in their leave. When they retired, both of them received the Leave encashment Salary.
In the case of Mr B and Mr C, the leave encashment salary is not taxable.
So we can conclude that the leave salary encashment received by the Central or state government employees at the time termination of employment is fully exempted.
Here, we need to keep in mind the meaning of government employee. It does not include employees local authority, foreign government and public authority.
(C) Leave Salary encashment exempted to an extent of some conditions
In the above-mentioned case, we discussed the government employees at the time of retirement.
What about non-government employees when they retire?
Non-government employees can get an exemption from taxability of leave salary encashment. This exemption is based on the minimum amount, based on the below-mentioned conditions as per section 10(10AA)(ii) of the Income Tax Act
Conditions – Minimum of which is considered for exemption
(1) . Actual amount Received as Leave Salary
(2) . INR 300000; This is a statutory amount. Suppose the employee claimed any deduction, as leave encashment will be deducted from the INR 300000.
(3) . Average Salary X 10
(4) . One month average salary for every completed year of service in the company less the actual leave taken in the period of service
We can use ((1* Completed Years of Service ) – the number of months of leave taken ) X average salary
Here, we need to find the Average Salary.
To find the average salary, we need to add the Basic Salary, Dearness Allowances and Commission as given below
| Basic Salary | The basic payment of the employee for the last 10 months |
| Dearness Allowances | If Dearness allowances forming part of retirement benefit only considered for this purpose, (for the last 10 months ) |
| Commission | This commission should be a fixed percentage of turnover for the last 10 months |
Example :
Mr Aravind gets a commission of INR 5000 monthly as a fixed amount, and he also gets a commission of a 2% on turnover.
To calculate the average salary, only the 2% commission on turnover will consider.
We need to calculate these amounts for the last 10 months preceding the date of retirement. Then, this total is divided by 10 (number of months) to find the Average
Mr John retires on 10th November 2019. To find 10 month’s average salary, we need to calculate the salary from the date of 11 January 2019 to 10 th November 2019.
To calculate the completed year of services, we consider only the years. It will not count fractions.
How to treat leave encashment salary from more than an employer
There may be chances that the employee received leave encashment salary for more than an employer. In this case, the maximum amount exempted from the taxable leave encashment salary for a previous year is INR 3,00,000.
So we have to keep it in mind that the total amount of leave salary encashment should not exceed INR 300000, which is the statutory deduction as per the Income Tax Act
Example of Calculation of Taxable Leave Salary
From the below information, Calculate the taxable leave salary encashment for Mr Alexander
| Period of Employment | 25 Years & 7 months |
| Leave provided to Mr Alexander | 2 month leave for every completed year in the company |
| Total leave availed | 2 months |
| Date of Retirement | 15-08-2019 |
| Leave encashment at the time of retirement | 280000 |
| Basic Salary | 10000 |
| Dearness Allowances | 3500 |
| Commission | 5% on turnover |
| Total Turnover | 1000000 |
Solution
To find the taxable leave salary, we need to find
(A) Completed Year of Services
Completed Year of Services – To find the completed year of services, we consider only the year. completed year of service is 25 years.
(B) Average Salary
To find the Average Salary, We need to follow the below steps
| Month | Basic Salary | DA | Commission |
| Oct (16 Days) | 5,162 | 1806 | 10,00,000 X 5% X (10/12) |
| Nov | 10,000 | 3,500 | = 41,667 |
| Dec | 10,000 | 3,500 | |
| Jan | 10,000 | 3,500 | |
| Feb | 10,000 | 3,500 | |
| Mar | 10,000 | 3,500 | |
| Apr | 10,000 | 3,500 | |
| May | 10,000 | 3,500 | |
| Jun | 10,000 | 3,500 | |
| Jul | 10,000 | 3,500 | |
| Aug – 15 Days | 4838 | 1694 | |
| Total | 1,00,000 | 35,000 | 41,667 |
Average Salary = ( Basic Salary + DA + Commission ) / 10
= (1,00,000 + 35,000 + 41,667 ) / 10
= 17,667
Computation of Taxable Leave Encashment Salary of Mr Alexander for AY 2019-2020
| Particulars | Details | Amount(INR) |
| Leave Encashment Received | 2,80,000 | |
| Less : Exemption u/s 10 (10 AA)(ii). Minimum of the below is exempted | ||
| (a) Actual amount Received as Leave Salary | 2,80,000 | |
| (b) Statutory Exemption | 3,00,000 | |
| (c) Average Salary X 10 Months | 1,76,667 | 1,76,667 |
| (d) ((1 X Completed Years of Services) – Leave Taken ) X Average Salary ((1 X 25 ) – 2) X 17667 | 4,06,341 | |
| Taxable Leave Salary Encashment | 1,03,333 |
(D) Treatment of leave salary paid to the legal heir
If the leave salary paid to the legal heirs, it will not be taxed. It is applicable in the case of Government employees also.
You can click here to check your Taxable Leave Salary
These are the important factors with regards to the tax on leave encashment. You can check the taxable leave encashment online through the below link.
Just click the link of Income Tax of India website and fill the details in the form and you will get the exemption and taxable amount of your leave salary encashment.
You can click here to check your Taxable Leave Salary
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