Leave salary, also known as income tax leave encashment, is the amount of money that an employee receives in lieu of unutilized leaves. It is taxable under the Income Tax Act, 1961.

The taxability of leave salary depends on when it is received.

• If the leave salary is received while the employee is still in service, it is fully taxable. However, the employee can claim tax relief under Section 89 of the Income Tax Act.
• If the leave salary is received at the time of retirement, superannuation, resignation, or death, it is exempt from income tax up to a certain limit. The limit is:
  • 3,00,000for employees of the central government or state government
  • 2,00,000for employees of other organizations

To claim the exemption, the employee must have completed at least 5 years of service.

The exemption is available for the leave salary that is actually received. If the employee dies before receiving the leave salary, the exemption will be available to the legal heirs.

Here is an example of how the taxability of leave salary is determined:

• An employee receives Rs.50,000 as leave salary while he is still in service. The entire amount will be taxable.
• An employee receives Rs.40,000 as leave salary at the time of retirement. He will be able to claim exemption for Rs.3,00,000, so the taxable amount will be Rs10,000.

EXAMPLES

• The state in which the employee is working.
• The type of leave being encashed.
• The employee’s salary and length of service.

For example, in the state of Maharashtra, under income tax an employee is entitled to 30 days of earned leave per year. If the employee is encashing their earned leave, they will be paid their full salary for the number of days of leave that they are encashing.

However, if the employee is encashing their sick leave, they will only be paid half of their salary for the number of days of leave that they are encashing.

The following is an example of how the leave salary is calculated in the state of Maharashtra:

• Employee’s salary: Rs.50,000 per year
• Number of days of earned leave being encash: 15 days

Leave salary = (50,000 * 15) / 365 = Rs.2,272.73

In this case, the employee would be paid Rs.2,272.73 for the 15 days of earned leave that they are encashing.

The leave salary calculations may vary slightly from state to state, so it is important to check with the specific state’s labours laws to get the exact calculation.

FAQ QUESTIONS

• Is leave salary taxable?

Yes, leave salary is taxable under the Income Tax Act, 1961. However, there are some exceptions. For example, leave salary received at the time of retirement is exempt from tax.

• What is the tax treatment of leave encashment?

Leave encashment is the amount of money that an employee receives in lieu of unused leave. It is taxable as salary income tax. However, there is a partial exemption for leave encashment that is received at the time of retirement. The amount of exemption is equal to the employee’s salary for the last 10 months of service.

• How is leave salary calculated for tax purposes?

Leave salary is calculated as the average salary of the employee for the 12 months of income tax preceding the month in which the leave is encashed .

• Is there any way to reduce the tax liability on leave salary?

There are a few ways to reduce the tax liability on leave salary. One way is to claim a deduction for any medical expenses that were incurred during the leave period. Another way is to claim a deduction for any travel expenses that were incurred during the leave period.

• What are the TDS implications of leave salary?

The employer is required to deduct TDS on leave salary at the same rate as the TDS on salary. The TDS rate is currently 10%.

CASE LAWS

• CIT v. Union of India (1982) 134 ITR 629: This case income tax held that leave salary received by an employee on retirement is exempt from income tax under Section 10(10AA) of the Income Tax Act, 1961. The exemption is available up to a maximum limit of Rs. 3,00,000.
• CIT v. Steel Authority of India Ltd. (2004) 268 ITR 437: This case income tax held that leave salary received by an employee on termination of service is also exempt from income tax under Section 10(10AA). However, the exemption is not available if the termination of service is due to the employee’s misconduct or negligence.
• CIT v. Bharat Heavy Electricals Ltd. (2006) 283 ITR 173: This case income tax held that leave salary received by an employee during the course of employment is taxable as income from salary. However, the employee can claim tax relief under Section 89 of the Income Tax Act, 1961.
• CIT v. Hindustan Petroleum Corporation Ltd. (2011) 337 ITR 441: This case income tax held that the exemption under Section 10(10AA) is available to all employees, irrespective of whether they are employed in the government or private sector.
• CIT v. Indian Oil Corporation Ltd. (2013) 358 ITR 372: This case income tax held that the exemption under Section 10(10AA) is not available to leave salary that is paid in excess of the employee’s entitlement.