As the famous saying goes — “All work and no play makes Jack a dull boy.” The same is applicable to employees of an organisation. Therefore, to overcome such a situation, employers in every sector, usually have a policy for providing annual leaves to their employees for a healthy work-life balance.

Employers may also have a policy of paying cash in lieu of leaves that have not been availed by the employees during the year or at the time of their retirement or leaving the organisation.

Leave encashment: The unutilised leaves to the employee’s credit may lapse or accumulate or can be encashed, depending upon the leave policy of the employer. The unutilised leaves are called ‘earned leaves’ and the amount received in lieu of this is popularly known as ‘leave encashment’ or ‘leave salary’.

Tax implications: As per the provisions of Section 10(10AA) of the Income Tax Act, 1961 (the Act), the amount received towards leave encashment from the employer is taxable as salary income of the employee. However, the Act also provides for certain exemptions in respect of leave encashment to an employee, subject to specified conditions.

These provisions can be categorised separately for government employees and non-government employees.

For central and state government employees: The amount received towards leave encashment at the time of retirement whether on superannuation or otherwise is tax free, that is the entire amount received is fully exempt from tax.

For non-government employees: The amount received towards leave encashment is exempt subject to specified conditions. The exemption is restricted to the least of the following:

>> Cash equivalent of earned leave to the employee’s credit only at the time of retirement whether on superannuation or otherwise (earned leave entitlements cannot exceed 30 days for every year of actual service rendered for the employer from whose service one has retired).

>> Ten months’ salary, which is calculated on the basis of average salary drawn during the period of 10 months immediately preceding retirement, whether on superannuation or otherwise.

>> Leave encashment actually received at the time of retirement whether on superannuation or otherwise.

Salary for the aforesaid purpose means basic salary and includes dearness allowance if terms of employment so provide, but excludes all other allowances and perquisites.

The limit is Rs 3,00,000, which can be availed of during the lifetime by an employee. It has been clarified that in case any amount received towards leave encashment is received by an employee from more than one employer, the aggregate amount so exempt should not exceed the overall exemption limit mentioned above. In addition, if the amount received towards leave encashment is received in one or more financial years, the exempt amount claimed earlier has to be taken into account while computing the present exemption.

For example, if the specified exemption limit of leave encashment in the present year is Rs 3,00,000 for non-government employees and in an earlier year, the employee had received Rs 2,00,000 towards leave encashment, which was not considered as taxable in that year, then the limit of the leave encashment in the present year to be exempt would be reduced to Rs1,00,000 (Rs 3,00,000 minus Rs 2,00,000).

(The writer is partner – tax

at KPMG. The views are personal)