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Leave encashment / leave salary – Is it taxable?

From time to time, you may encash your leaves – when they are due to expire at the end of the year, when you resign and leave a company, or when you retire.

Do you have to pay tax on the amount received from leave encashment? Is there any tax deducted at source (TDS)? Does the tax change if you are a government servant or working with a private firm?

Let’s understand what the income tax rules for leave encashment are.



You encash your leaves on mainly three occasions:

  • When the leaves are due to expire (while you are still in service)
  • When you resign from a company and leave the organization
  • When you retire (at the time of superannuation)

Whatever the reason for encashing the leaves, you get some amount in return. And consequently, there are income tax implications for this amount (also known as “leave salary”).

The income tax treatment (and benefit, if any) depends on the reason due to which the leaves are encashed. It also depends on whether you are in a government job or work for a private company.


Leave encashment while in service

Central or state government employees

The amount received from any leave encashed while you are still in service is added to your income, and is fully taxable. It is taxed as per the income tax slab applicable to you.

(To know the current income tax slabs, please read “Income Tax (IT) Slabs / Brackets and rates”)

This situation applies to encashment of leaves that would otherwise expire / lapse.

Employees of private corporations

The taxation of leaves encashed by employees of private firms while still in service is the same as that for government employees – the amount received from this is fully taxable.

Leave encashment at the time of resignation or retirement

Central or state government employees

The amount received from leave encashment is fully tax free for government employees in this case. (This exemption is available under Section 10(10AA)(i) of the Income Tax Act).

There is no upper limit or cap – the entire amount received is fully tax exempt.

Employees of private corporations

The situation is not so rosy for employees or private firms!

The amount exempt from income tax is the minimum of the following:

  • The amount actually received from leave encashment
  • The cash equivalent of leaves available in your account (leave balance) (not exceeding 30 days per year of actual service)
  • Last 10 months’ average salary
  • Rs. 3 Lakhs

Please note that the tax exemption is allowed for the least / lowest of these four.

Please also note that even without the consideration of other factors, the tax exemption is limited to a maximum of Rs. 3 Lakhs.


Some clarifications

Average Salary

Here, salary would include your basic, dearness allowance (DA) and any commission received by you as a fixed percentage (%) of sales or turnover.

You have to consider the average salary for the 10 months immediately preceding the month of your resignation or retirement.

Cash equivalent of leaves

For calculating this, the maximum allowable leave per year is 30 days for each year of your service in that company.

Thus, even if your company / organization allows, say, 40 days of encashable leaves every year, you need to count only 30 days per year.

The cash equivalent should be calculated depending on your company’s policy. For example, if your company pays you leave salary (leave encashment) depending on the last drawn salary, calculate this based on your last drawn salary.

Example

Your company allows 40 days of encashable leaves every year. You served from 1 Jan 2005 to 31 Dec 2008. You took 5 leaves in 2005, 15 in 2006, 19 in 2007 and none 2008.

For calculating the number of leaves for finding “Cash equivalent of leaves”, the number allowed would be:

  • 2005: 30
  • 2006: 25
  • 2007: 21
  • 2008: 30

The total would be 106 leaves, and you would find the cash equivalent for that.

Government Employee

The term government employee means an employee of the central or state government. It does not include employees of local authorities or bodies like municipal corporations or panchayats.


Retirement or Resignation?

There has been some debate regarding whether the exemption for leave encashment under section 10(10AA) is available only at the time of retirement (superannuation), or at the time of resignation as well.

Please note that this tax benefit is available both at the time of retirement and at the time of resigning from a company.

Lifetime Limit

The limit of Rs. 3 Lakhs is a lifetime limit.

That is, even if you resign from different jobs (of course, at different times), the total available exemption is capped at Rs. 3 Lakhs.

The resignations may be in the same financial years, or in different financial years.

Example

You worked for company A, and resigned from it in July 2003. You encashed leaves, and received Rs. 2 Lakhs.

You had joined company B then, and now, you resigned from company B in February 2009. You received Rs. 2.5 Lakhs for this encashment.

In this case, the maximum exemption that you can claim is Rs. 1 Lakh (Rs. 3 Lakh lifetime limit less Rs. 2 Lakhs exemption already claimed) irrespective of how much is allowable as per the 4-condition rule stated above.

Tax Deducted at Source

While paying you the amount for leave encashment, your company would deduct TDS from the amount.

Implications and saving the tax amount through Section 89(1)

When you encash accumulated leave, the entire amount would become taxable in this year – although the amount actually belongs multiple years, and not just this year.

This can greatly increasing your income tax liability, especially because most likely, the entire amount would fall in the highest tax bracket!

Is there a way out? Yes, you can get some relief using Sec 89(1).

Please read “Saving tax on leave encashment amount – Section 89(1)”.

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Comments

  1. Anonymous says:

    Hi Rajan,

    Yes, it would be taxable.

  2. p.rajan says:

    Previledge encashed of 4 years accumulation Rs.105000.00 during resignation,whether it is taxable and TDS is deductabbe.

  3. Anonymous says:

    Hi Dinesh,

    Encashment of privilege leave is fully taxable.

    Notice pay received would be treated as salary, and would be taxable.

  4. I got confused with regard to your response to previous query. You mention that Leaves encashed are exempt for private employee upto an upper cap at the time of resignation. Then why It would be taxable for Rajan?

    Another query is related to Notice pay salary. My previous company was closed down (succumbed to recession). It gave us one month notice period salary and leave encashment. Are they exempt under sections 10 10A/B?

  5. Chidanand says:

    Hi,

    I received a Leave encashment of Rs 45000/- in the full & final settlement after my Resignation at one Private company in this financial year.

    Should this Rs 45000/- is taxable or not, as per your information for private company if a employee resigns then the leave encashment is not taxable till the limit of 3 lakhs.

    Can be please inform me on this

  6. Anonymous says:

    Hi Chidanand,

    Rs. 3 Lakhs is the upper limit for exemption. The amount actually exempt from income tax is the minimum of the 4 things mentioned in the article.

  7. Chidanand says:

    Hi,

    I just want to know whether Rs 45000 which I got from Leave encashment after my resignation as full & final settlement is taxable or not.

    As per your information it is not taxable if I resigns from the company.

  8. Anonymous says:

    Hi Chidanand,

    It would be as described in the article.

  9. shantanu says:

    Sir,
    I am presently working in pvt. sector.
    I am having bal. of 60 days leave at present (31.03.09)
    It it taxable If I take 30 days leave encashment

  10. Anonymous says:

    Hi Shantanu,

    It would be as described in the article. Please read the article along with your relevant details (resignation / while in service, your salary, etc).

  11. shiny george says:

    pl advice if pf should be deducted from the terminal surrender amount. If it is so deducted and equal contribution paid by the employer, should the pf so deducted be considered as an admissible 80c deduction. If the income itself is tax free can a deduction from it be allowed as a deduction

    Regards
    Shiny

  12. Anonymous says:

    Hi Shiny,

    There was a court case about this, and the Madras High Court has ruled that PF should not be deducted from leave encashments.

    If PF has been deducted, and employers’ contribution has been received by the PF trust, these should be adjusted against PF / employers’ contribution payable in the future.

  13. sir,
    kindly cause to clarify whether encashment of earned leave during availment of ltc is taxable or not

  14. WHAT AMOUNT OF LEAVE ENCASHMENT IS TAX FREE ON RETIREMENT FOR CALCULATION OF INCOME TAX?

  15. sir,

    I havebeen working with a company B ,My anuual salary was 305000.(date joing 16/01/2009 and resinged on 30/01/2010)but in my finall settlment gross earning was 23,537 in that 11.735 rs deducted as tax and 7,394 rs dedected as notice pay which is paid me as leave encashment
    sir,
    is this calculation is correct and again again gratity is 5817.

  16. mohan Lal Agarwal says:

    Sir,
    I am in govt.Services and i got cash for my Leave for 15 days whether it is taxable or not.Please refer the decision made by Supreme court in the matter of commissioner of income tax west bangal v/s talimmed club limited in 1999

  17. Hi,
    As per AS 15, company has to provide for the PL & Bonus payable at year end (31.03.2010) in the A/cs say 2009-10.
    Where actual payment of the same is done before 30.09.2010.
    My query is
    1) when the PL & Bonus is taxable to employees? F.Y. 2009-10 or 2010-11
    2) Even if the said amount is mention in CTC i.e. it is a part of salary?
    3) What about the LTA / LTC, if same way payment is make?

    Thanking You
    Kirti

  18. M.L.Gupta says:

    I am officer in FCI and as per instructions PSU employees are entitled for maxium 300 days EL/HPL encashment & Income Tax exemption upto Rs.3 lac on Earned /half Pay leave encashment after retirement. The details of EL/HPL encashment and amount received by me on retirement are as under:
    1. 250 days EL encashment Rs.260000-00
    2. 60 days half pay Leave encashment Rs. 50000-00
    Total 310 days EL/HPL Encashment Rs.310000-00
    Please confirm on which amount there will be tax liability

  19. Manoj Toshniwal says:

    In sytem in our company, salary is deduct when employee is absent. But we give one leave salay at the end of financial year. Till today is ok. but now we are facing a problem in case of maternity leave, if employee take 150 days leave then what can we do. can we deduct 60 days leave (150 Days less 90 ESIC). Please sug.

  20. Hi,
    I have recently resigned the company. During my service, I have paid some portion my salary to superannuation fund. As per the LIC policy, if the person paid less than 5 years, they will settle 50% immediately and other 50% interest will be deposited on month over month to my account. Please clarify me the above settlement is taxable or not? Thanks in advance.

  21. I have resigned from a pvt company in Kolkat after 12 years of service. The rules for leaves were as follows :
    PL – 21 days per year on prorata basis. can be accumulated for 6 months.
    ML -10 days per year on prorata basis. can be accumulated for 3 months.
    My total accumulated leaves were PL – 84 days & ML – 82 days

    However I have been paid for PL- 84 days and ML- 30 days and their calculation is
    PL – 21 X 6 = 126 days can be accumulated
    ML – 10 days x 3 = 30 days.

    I would request you to advise if this is correct and if not where I can get justice.

  22. Howdy! I know this is kinda off topic but I was wondering
    if you knew where I could find a captcha plugin for my comment form?
    I’m using the same blog platform as yours and I’m having trouble finding one?
    Thanks a lot!

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