As a company engaged in the business of payroll processing and statutory compliance related to payroll, we wonder if the tax law governing tax exemption on Leave Travel Allowance (LTA) is among the most complex tax legislations in India. Each year organizations face significant difficulty while calculating tax exemption on LTA when they carry out the year-end tax compliance work. Let us examine the law and the practice related to calculation of LTA exemption in this post.
Section 10(5) of the Income Tax Act, 1961 (along with Rule 2B of the Income Tax Rules) governs calculation of tax exemption on LTA. The key conditions as specified by Section 10(5) (and Rule 2B) are as follows.
LTA payment to employees
LTA should have been paid/be payable to an employee if an employee wishes to avail tax exemption on LTA. In other words, if an employee does not receive an amount under a separate head of pay -- called for example LTA or LTC -- for the purpose of meeting leave travel expenses, the employee cannot avail tax exemption on account of leave travel. Also, in any particular tax year (Apr to Mar), tax exemption shall be limited to the LTA (or by whatever other name the head of pay for the purpose of meeting leave travel expenses is called) amount which is paid to an employee in that tax year. I
Illustration: An employee is eligible to receive Rs 12,000 in a tax year (Apr to Mar) under the LTA head of pay. However, the employee can choose not to receive the LTA amount in a tax year and he or she can carry forward the LTA amount to the next tax year. What is the maximum LTA amount on which tax exemption should be calculated?
If an employee chooses to receive LTA each year (without carrying it forward), the maximum tax exemption the employee can receive shall be Rs 12,000 per tax year.
If an employee chooses to carry forward the amount in tax year 1 and receives Rs 24,000 under LTA in tax year 2, his LTA tax exemption shall be Rs 0 in tax year 1 since he did not receive any amount under LTA and in tax year 2, the maximum tax exemption he can receive on LTA shall be Rs 24,000.
How often can tax exemption be availed?
The tax exemption on LTA can be availed only in respect of two journeys performed in a block of four calendar years.
This is where the complexity related to calculation of tax exemption on LTA starts. According to the income tax law, an employee should have undertaken leave travel for the purpose of claiming tax exemption and in a block of 4 calendar years the employee can claim tax exemption for 2 journeys.
While income tax is calculated on LTA paid during a tax year (Apr to Mar), the exemption itself shall be provided only for 2 journeys across 4 calendar years. The first block (as specified by the tax department) of 4 calendar years commenced in Jan 1986. We are currently (Nov 2013) in the block starting Jan 2010 and ending in Dec 2013. An employer, before providing tax exemption on LTA, needs to check if the employee has availed tax exemption for more than 2 journeys in the particular block of 4 years. For example, let us assume that an employee claims tax exemption on LTA for the journeys he undertook in Apr 2010 and Apr 2011. If in the tax year Apr 2012 to Mar 2013 the employee claims tax exemption on LTA for the journey he undertook in say, Apr 2012, the employer should not provide any tax exemption since the employee has already used up the tax exemption on 2 journeys in the block (Jan 2010 to Dec 2013).
If an employee works with the same employer through the block of 4 years, the employer will know if the employee has availed tax exemptions for 2 journeys in the block. But if an employee moves from one employer to another during a block of 4 years, the second employer should check with the employee whether the employee has received tax exemption for more than 2 journey thus far in the block from the earlier employer and provide tax exemption accordingly.
In addition to the above, if an employee does not avail tax exemption (for either 1 or 2 journeys) on LTA in a block of 4 calendar years, he or she can avail tax exemption for 1 journey in the first year of the next block of 4 years. In other words, an employee can avail up to 3 exemptions in a block of 4 years if the employee did not avail tax exemption on 1 or 2 journeys in the previous 4 year block.
The income tax act only talks about a maximum of 2 (or 3) journeys for the purpose of tax exemption in a block of 4 years. An employee can undertake both the journeys in the first year and claim tax exemption in the first year itself. If 2 journeys are undertaken in the first year itself, the employee has to wait for the next block of 4 years before he can avail tax exemption on LTA.
We wonder how the income tax department came up with the idea of looking at calendar year for the purpose of LTA tax exemption. Maybe the calendar year idea came from statutes such as the Shops and Establishments Act which mandate providing leave to employees as per calendar year.
Also, why a maximum of 2 tax exemptions in a block of 4 years? Employers find it difficult to keep track of the number of times an employee avails tax exemption on LTA. The tax department could allow tax exemption on LTA each tax year. This would make the life of employers easy. After all, what is wrong in encouraging people to take a vacation each year instead of twice every 4 calendar years?
What does "travel expense" mean?
Travel expenses refer to the cost of travel (ticket fare etc.) alone. Expenses on boarding, lodging, sightseeing etc. should not be considered for the purpose of tax exemption. In addition, travel expenses should pertain to leave travel within India. Expenses on overseas travel cannot be considered for the calculation of tax exemption.
Can travel expenses of an employee's family be considered?
Yes, travel expenses incurred on both the employee and his/her family members can be considered for tax exemption subject to the following conditions.
a. The employee should have taken leave from his organization and travelled along with his/her family members for availing the tax exemption. In other words, if an employee does not travel, the travel expenses of his family members cannot be considered for tax exemption.
b. "Family" in this regard means (i) the spouse and children of the employee, and (ii) the parents, brothers and sisters of the employee provided that they are wholly or mainly dependent on the employee. Please note that if the parents, brothers and sisters of the employee are not dependent on the employee, their travel expenses cannot be considered for the purpose of tax exemption.
There is a twist with regard to the travel expenses of an employee's children as per sub-rule (4) of rule 2B of the Income Tax Rules. Tax exemption on LTA is not be admissible to more than two surviving children born after 1-Oct-1998. This restriction is not however applicable in respect of children born before 1-Oct-1998, and also in cases where an employee, after getting one child, begets multiple children (twins/triplets/quadruplets, etc.) on the second occasion. In other words:
a. the exemption is admissible to all surviving children born before 1-Oct-1998;
b. the exemption is admissible to only two surviving children born on or after 1-Oct-1998. However, if an employee after his or her first child, begets twins, triplets etc. the multiple children (twins, triplets etc.) on the second occasion will be counted as one child only.
Also, Section 2 (15B) of the Income Tax Act defines a child as including step-child and an adopted child of an employee.
Why should the income tax law penalize employees if they have more than 2 children by not extending the law to cover travel expenses of the third (and subsequent) children unless they are twins, triplets etc.? Why can't the tax department be considerate towards families with more than 2 children? Surely, there must be better ways of incentivizing people to keep their families small!
Many people believe that the entire travel expense can be considered for tax exemption. Not quite. There are several conditions one needs to consider in order to arrive at the exact amount of tax exemption. We have covered the conditions in our blog post here.
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