How will I be taxed for leave encashment?

Is leave encashment exempted under Sec 10 (10AA) of the Income Tax Act on retirement? Is the money received from an employer towards encashment of pending leaves be considered for exemption irrespective of the number of times I switch jobs?

Till March, the encashment limit for an employee was 3 lakh. My current employer has paid me 1.5 lakh towards leave encashment and this is not taxable. Now that the government has increased this limit to 25 lakh, will the exemption limit at my future job with a prospective employer be 23.5 lakh?

—Name withheld on request

As per the tax laws, any payment received by employees from their employer towards encashment of earned leaves at their credit, at the time of retirement, whether on superannuation or otherwise, shall be exempt from tax, subject to the specified limits.

It is important to note that the value of exemption is required to be calculated to as per the method prescribed in this regard under the Act, with a maximum cap of the specified limit.

From the language of the provisions and based on judicial precedents, there is a view prevailing that the term ‘retirement (whether on superannuation or otherwise)’ is wide enough to include resignation. Thus, leave encashment received from employer upon resignation from employment shall be exempt from tax, subject to the specified method of calculation and limits. It may, however, be noted that any leave encashment received while continuing to be in employment with the employer is taxable in hands of employee.

Also, where any exemption for leave encashment has been considered in one or more previous years, such exemption amount considered previously, shall be reduced from the total eligible limit of exemption to be considered in the future. As per the current law, the overall leave encashment exemption claimed by an employee during his lifetime, from one or more employer, cannot exceed the total limit specified in the said provisions (which is currently 25 lakh).

It is assumed that that you have resigned from your current employment and received 1.5 lakh as leave encashment in March this year which was fully eligible for exemption as per the specified method of calculation. In such case, if you have not availed of this exemption in any other prior years, you will be eligible to avail maximum exemption of 23.5 lakh (as per the current limits) at the time of resignation from your subsequent employment(s), subject to satisfaction of other conditions.

Parizad Sirwalla is partner and head, global mobility services, tax, KPMG in India.

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Updated: 03 Sep 2023, 11:00 PM IST

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