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Leave Encashment by HA TAX

Leave Encashment

Jun 10, 2022

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Leave Encashment

Any employee who works in a company which follows standard work practices is eligible to avail of various types of leaves such as causal, medical, gazetted and many more. The leaves are categorised as carrying forward or non-carry-forward. Carried forward leaves can be encashed which is generally referred to as Leave Encashment.

Carry forward leaves are one which can be carried forward next year. As per the labour law, every salaried employee is eligible to get minimum paid leave every year. But there are chances that one doesn’t use all the number of leaves. The unutilised leaves can be carried forward or can be encashed. 

This leave enchantment leaves an employer to compensate employees with the accumulated unutilised leave balance at the time when an employee leaves the company or retires. 

The taxation aspect of Leave Encashment is one of the major points of consideration. The Leave Encashment during the service period of an individual is fully taxable under the heading of “Income from Salary”. However, Leave Encashment at the time of retirement or resignation taxation is either fully or partially exempt (depending upon the category of employee). 

Note: One can receive relief as per Section 89 for the first case.  

Some of the exemptions that one gets are-

  1. At the time of retirement or resignation, an employee of Central or State Government receives Leave Encashment which is fully exempt from taxation.
  2. Legal heirs of deceased employees receive leave exemption which is fully exempt
  3. Non-Government employees are governed by Section 10(10AA)(ii) and get a suitable exemption on its basis
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    Calculation of Leave Encashment

    Particulars Amount
    Leave Encashment received (A) XXXXX
    Less: Exemption under Section 10(10AA) –   (B) Least of the following: XXXX
    Amount notified by the Government** Rs 3,00,000 (C) 3,00,000
    Actual leave encashment amount (D) XXXX
    Average salary* of last 10 months (E) XXXX
    Salary per day * unutilised leave (considering maximum 30 days leave per year) for every year of completed service (F) XXXX
    Leave Encashment taxable – (A) – (B) XXXX

    *Salary for this purpose includes basic salary, dearness allowance and commission based on a fixed percentage of turnover secured by the employee** Specified amount of Rs 3,00,000 is the aggregate amount allowed as exemption irrespective of the frequency of leave encashment received by the employee by various employers. If an employee has utilised Rs 2,00,000 already at the time of the first resignation, he is only entitled to use the balance of Rs 1,00,000 for the exemption computation next time. Hence, the overall employee is allowed a total exemption of only Rs 3,00,000 with respect to leave encashed from all employers.

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    Important Points

    Some of the important points that have to be kept in consideration for the Leave Encashment are:

    1. The term Salary includes Basic + Dearness Allowance + Commission (as per the contract. However, other allowances are not included.
    2. The average salary has to be taken into consideration (that is drawn by the employee during the 10 months preceding retirement).
    3. If the employee has received leave encashment in any one or earlier previous year(s) also and had availed of the exemption in respect of such amount, the limit of Rs. 3,00,000 specified above shall be reduced by the amount of exemption availed earlier.
    4. Leave encashment which is received by the family members after the demise of the employee is not taxed.
    5. The retirement of employees may be of various kinds. It may be on superannuation or voluntary such as resignation. This section applies equally to a case of voluntary retirement on account of resignation.
    6. The amount which is received as Leave Encashment on resignation by an employee is treated the same as the amount which is received at the time of retirement. On a similar basis, the tax will be levied.
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