Leave encashment and tax

Hello Nitin,

1. Your entitlement for leave encashment depends upon the HR policy of your company. Generally companies do provide for a leave enashment as [Last earned basic salary p.m X leave balance in months]. You need to check with your employer whether all leave balances are encasheable. Generally sick leaves and casual leaves are not encasheable. Certain companies do pay the leave encashment on the basis of last earned gross salary instead of basic salary.

2. You are entitled for a statutory minimum gratuity of Rs.387,692 (This is as per the Gratuity Act). In case your employer has a gratuity scheme which provides for a benefit which is different from the requirement of the Act, you will be entitled for such benefit.

3. a) This is how you may compute exemption on leave encashment:

Ø  Step 1 – Completed years of service = Retirement date – Joining date (only completed years to be taken).

Ø  Step 2 – Leaves due per year as per terms of employment [in days] = Leave entitlement per month × 12.

Ø  Step 3 – Leaves due per year [in days] = Lower. (a) leaves due per year as per employment terms ; or (b) 30 days.

Ø  Step 4 – Earned leave outstanding [in months] = [(Leaves due per year × Completed years of service) – Total leaves availed (in days) during period of service – Leaves (in days) for which encashment taken during period of service] ÷ 30.

Ø  Step 5 – Salary for last 10 months = Salary including dearness allowance (if terms of employment provide) but excluding all other allowances and perquisites + Commission based on fixed percentage of turnover {Gestetner Duplicators (P) Ltd. v. CIT [1979] 117 ITR 1 (SC) ; [1979] 1 Taxman 1 (SC)}. Salary is to be computed for the 10 months immediately preceding the date of retirement.

Ø  Step 6 – Average salary = Salary for last 10 months ÷ 10.

Ø  Step 7 – Cash equivalent of leave = Earned leave outstanding (in months) × Average salary.

Ø  Step 8 – 10 months average salary = 10 × Average salary.

Ø  Step 9 – Leave salary exempt from tax = Lower of (a) Cash equivalent of leave ; or (b) 10 months average salary ; or (c) Amount specified, i.e., Rs. 3,00,000 ; or (d) Actual leave salary received.

b) Calculation for exemption on gratuity:

Ø  Step 1 – Compute ‘Salary’ for this purpose : Salary including dearness allowance (if the terms of employment so provide) but excluding all other allowances and perquisites + Commission based on fixed percentage of turnover (Total salary drawn for 10 months preceding the month of retirement is to be taken).

Ø  Step 2 – Determine period of service (years) : Retirement date – Joining date (only completed year are taken into account).

Ø  Step 3 : Determine half month’s salary for every completed year of service : Period of service × salary ÷ 20.

Ø  Step 4 : Gratuity exempt from tax is the lower of the following :

(a) Half month’s salary for every completed year of service ; or

(b) Notified limit, i.e., Rs. 10,00,000 ; or

(c) Amount actually received as gratuity.

Regards,

Pradeep.