Leave encashment is a process that gives the right to employees to convert their unused or accumulated leave days into cash. Salaried employees are given various types of paid leave like sick leave, casual leave, and annual or earned leave. Depending on the employer’s policies, some of these leaves are carried forward to the next year or indefinitely in some cases. Interestingly, these leaves can also provide financial benefits. In this article we will explain about leave encashment under section 10(10AA) of Income Tax Act and the tax on leave encashment.
Table of Contents
What is leave encashment under section 10(10AA) of Income Tax Act?
According to labor laws, employer provides a minimum number of paid leaves each year to every employee. However, every employee doesn’t use all their leave within the year. Hence many employers give the option to carry forward any unused paid leave to the next year or indefinitely.
As a result of that, employee may accumulate a balance of unused leave till he retires or resigns from the company. Employers have to pay the cash for these unused paid leave days and this process is called as leave encashment.
What are the types of leaves?
1. Medical Leave
The purpose of these leaves to give the rest to those employee who are unable to work due to sickness and these leaves are paid. The employees can take these leaves for 7 to 14 days depending upon company’s policy. Medical leave is not eligible for leave encashment.
2. Casual Leave
These leaves are commonly used by employees and can typically be taken for seven days to 14 days depending upon employer’s policy. Employee is required to inform his employer in advance about the casual leave and its duration. If carry forward of these leaves is allowed as per the company’s policy, the employee may be eligible for leave encashment for such leaves.
3. Privilege Leave
Employees can take this leave by giving prior notice to the employer and it is also. If it is not used, these leaves can be accumulated and encashed in future depending on the company’s policy regarding privilege leave.
4. Maternity Leave
Pregnant female employees are entitled to maternity leaves for a period of 12 to 26 weeks. It is paid leaves. Employers may also grant an unpaid extension for up to 16 months. No deductions for such leaves are not made from the salary during this period. Maternity leave is also not eligible for leave encashment.
5. Paternity Leave
This leave is available for those employees who have become new fathers recently. These leaves can be taken for up to 15 days before or after date of the child’s birth and is available for up to 6 months from date of the child’s birth depending upon company’s policy. Paternity leave is not also eligible for leave encashment.
6. Floating Holidays
Employees also receive paid leave for national holidays, festivals, and weekly offs without any deductions from their salary. These holiday leaves may be eligible for leave encashment as per company’s policy.
7. Half-pay Leave
It is available only to government employees. It can be taken after completing 1 year of service. After taking these leaves, employees receive half of their daily salary. The half-pay leave may be eligible for leave encashment depends on the policy of government organization.
8. Quarantine Leave
If family or neighborhood of an employee is affected by an infectious disease, they can take quarantine leave so that they can prevent the spread of the disease among other employees. Quarantine leave is not also eligible for leave encashment.
9. Sabbatical Leave
Employees can also take the sabbatical leave to pursue further education or training relevant to their field. These leaves are paid leaves. Sabbatical leave is not also eligible for leave encashment.
Taxation of leave encashment under section 10(10AA) of Income Tax Act
1. Taxation on leave encashment during the period of service
When leave encashment is received by an employee for his unutilized paid leave during their employment, such amount received of leave encashment is considered taxable under the head of salary. However, such employee can take tax relief under Section 89. To take this relief, employee is required to fill out Form 10E available on the income tax portal which can be submitted online.
2. Taxation of leave encashment on retirement or resignation
At the time of retirement or resignation, employee can request to receive the cash for their accumulated paid leave, however the conditions of encashment vary depending on the type of organization. The taxability of leave encashment received in difference scenario have been explained below:
a) Leave Encashment Received by Legal Heir
If an employee dies before availing of leave encashment, his legal heir can receive the full amount of leave encashment on behalf of the deceased employee. Such amount received is exempt from income tax in the hands of legal heir.
b) Leave Encashment Received by Government Employees
Employees working in the central or state government organizations can also claim their paid leave encashment upon retirement or resignation. Such amount received is fully tax-exempt in the hands of these employees as well.
c) Leave Encashment Received by Non-Government Employees
Employees working in the private or non-government sectors can receive the cash for their paid leave upon retirement or resignation. The maximum tax exemption amount is specified under Section 10(10AA) of Income tax act 1961 for such case.
i) How to calculate leave encashment for non-government employees?
The employee working in private or non-government organization can take the tax exemption as specified in section 10(10AA) of income tax act as explained below:
| Particulars | Amounts (₹) |
|---|---|
|
Amount of Leave encashment received (A)
|
XXXX
|
|
Less: Amount of exemption allowed under section 10(10AA)(ii) (Least of the below) |
(XXXX) |
|
1. Amount notified by govt (₹25,00,000)
|
XXXX
|
|
2. Actual amount of leave encashment
|
XXXX |
|
3. Average salary of last 10 months |
XXXX |
|
4. Salary per day *unutilized leave days for every year of completed service |
XXXX |
|
Leave encashment taxable (C=A–B) |
XXXX |
- Note 1: Salary includes basic salary and dearness allowances, and any commission received is also considered for this section. The salary for 10 months is based on the salary received during the 10 months prior to retirement or resignation.
- Note 2: The specified amount of ₹2,500,000 is the total exemption notified by government, regardless of how many times the leave encashment is received from various employers.
- Note 3: If an employee has already used ₹500,000 out of 2 500,000 at the time of their first resignation, he is entitled to use the remaining ₹2,000,000 for future period. Hence the total exemption allowed for leave encashment from all employers is limited up to ₹2,500,000.
- Note 4: If leave encashment is received by an employee from two or more employers in the same year, the maximum exemption will remain ₹2,500,000.
- Note 5: The exemption under Section 10(10AA) is available irrespective of the tax regime.
ii) Example of Leave encashment
| Particulars | Amounts (₹) |
|---|---|
|
Amount of Leave encashment received (400 days* ₹2,000) |
800,000
|
|
Less: Exemption allowed under section 10(10AA)(ii) – Least of the below: |
(600,000) |
|
1. Amount notified by the Government (₹2,500,000) |
|
|
2. Actual leave encashment received (₹800,000) |
|
|
3. Average salary for 10 months (₹60,000*10 months= ₹600,000) |
|
|
4. Rs ₹2,000 * (30 days*20 completed years of service less 200 utilised leave) = ₹800,000 |
|
|
Leave encashment taxable as under the head of salary |
200,000 |
- Ram’s leave encashment received: ₹800,000
- Exemption allowed under Section 10(10AA): ₹600,000 (least of the four conditions)
- Taxable amount: ₹200,000 (₹800,000 – ₹6,00,000)
Final Words
Section 10(10AA) of Income Tax Act provide a tax exemption for leave encashment to government and non-government employees depending upon time of receiving such encashment. If you are a retired employee or is going resign from current job, then to get update about Section 10(10AA) of income tax act can be beneficial for your financial planning.
Frequently Asked Questions (FAQ)
In short, leave encashment means receiving the cash of unutilized leave from your employer.
Yes, it is taxable. But its taxability depends upon type of employee and time of receiving the leave encashment.
The leave encashment is a perquisite for the employee, and the taxability is dependent on whether the leaves are encashed during the period of service or at the time of retirement or resignation.
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