In this article I have explained the various provisions regarding the taxability of leave salary -
What is leave salary?
As per service rules, an employee gets different leaves. An employee has to earn leave in the first instance and only when he has leave to his credit, he can apply for leave. If a leave (standing to his credit) is not taken within a year, as per the service rules, it may lapse or it may be encashed or it may be accumulated. The accumulated leaves standing to the credit of an employee may be availed by the employee during his service time or, subject to service rules, such leaves may be encashed at the time of retirement or leaving the job. Encasement of leave by surrendering leave standing to one’s credit is known as “leave salary”
For the purpose of discussing the tax treatment of leave salary, we shall have two types of employees; Government and non-government employees. Based on the status of the employee, the tax treatment of the leave encashment differs.
If the leave encashment has been taken during the continuity of the employment, it will be completely chargeable to tax irrespective of the status of the employee. However relief can be claimed under section 89.
In the case of a central or a state government employee, an amount received as cash equivalent of leave salary in respect of the period of earned leave at his credit at the time of his retirement (whether on superannuation or otherwise) is completely exempt from tax under section 10(10AA)(i)
In the case of a non government employee (including employee of a local authority or public sector undertaking), leave encashment is exempt from tax on the basis of least of the following under section 10(10AA)(ii) –
1) Period of earned leave (in number of months) to the credit of the employee at the time of his retirement or leaving the job multiplied by the average monthly salary; or
2) 10 months’ salary (on the basis of the average of the last 10 months salary); or
3) The amount specified by the government i.e. Rs. 3,00,000/-
4) Leave encashment actually received at the time of retirement.
Now the method of finding out the leave standing to the credit of the employee at the time of retirement or at the time of leaving the job is as follows –
a) Find out the duration of service in number of years (ignore any fraction of year)
b) Find out how many days of leave are credited for each year of service in the name of the employee. Earned leave entitlements cannot exceed 30 days for every year of actual service rendered by the employee. For instance, if earned leave is credited at the rate of 40 days leave for each year of service, for the purpose of calculation, the same shall be made at the rate of 30 days leave for each year of service. If however, earned leave is credited at the rate of 25 days leave for each year of service, the calculation shall be made at the rate of 25 days leave for each year of service.
c) Find out the earned leave actually taken or encashed (in number of days) during the service time.
Once all the figures are determined, the computation shall be made as follows – [(Step (a) * Step (b) – Step (c))/ 30]
The method of finding the average monthly salary is rather simple – Salary for this purpose means basic salary and includes dearness allowance if the terms of employment so provide. It also includes commission based upon the fixed percentage of turnover achieved by an employee. “Average salary” for the aforesaid purpose is to be calculated on the basis of average salary drawn during the period of 10 months immediately preceding the retirement.
There might be a case where leave encashment is received from more than 1 employer(s). In such a case where leave salary or leave encashment is received by a non-government from two or more employers (maybe in the same year or different years), the maximum amount of exemption under section 10(10AA)(ii) during the lifetime of the concerned employee cannot exceed Rs. 3,00,000/-