Income Tax treatment of your leave encashment

Leave salary is taxable in certain cases based on the type of employment and time of encashment. An employee is eligible for leave based on the service rules of company where he is working. After joining a company an employee will earn leave as per his eligibility and after earning it he can claim those when ever requirement arises.

At the end of the year, leave to the credit of employees are accumulated and carried forward to the next year. In some companies based on their service rule, employee has to avail certain amount of leave or else it will lapse. Based on the service rule such accumulated leave can be encashed during the service or at the time of leaving job or even at the time or retirement.Income Tax treatment of your leave encashment

Different provisions are been set in income tax act which are discussed below;

Withdrawal during your service

Leave salary withdrawn during the continuity of your employment with your employer will be chargeable to income tax and nothing will be exempted.

Income tax treatment for your leave salary received during employment will be the same for government employee and for a non government employee. For both, leave salary withdrawn during employment is fully taxable.  

Leave Salary at the Time of Retirement or Leaving Job

For Government Employee

If you are a government employee then the entire amount received during the financial year on your retirement or while leaving job will be exempted from tax.

For Non Government Employee

If you are a non government employee then the withdrawn amount will be partly exempted to the least of followings;

  1. 10 months average salary before retirement or leaving job
  2. Rs. 3, 00,000
  3. Actual leave encashment received from employer
  4. Period of earned leave to the credit of the employee at the time of his retirement or leaving job

How Average salary is calculated

Step 1: Basic Salary + Dearness Allowance forming part of your salary + commission earned as a fixed percentage of turnover achieved by employee

Step 2: The above calculation has to be done for the last 10 months before your retirement or leaving job. Then the amount that you arrived at will be divided by 10 to get the average salary.

How period of earned leave is calculated

  1. Find out your duration of service in the company. While calculating duration of service in year you need to ignore any fraction of year.
  2. Find out the earned leave entitlement as per the service rule (eligibility per year * number of years in service). If your entitlement for a year is in excess of 30 days per year then such entitlement should be restricted to 30 days per year and your leave entitlement should be calculated as 30 days * number of years of service
  3. Calculate the earned leave if any encashed during your service time
  4. To arrive at the final calculation of leave salary you need to do the following calculation

[(Step 1 * step 2) – (step 3)] / 30

Example:

Mr A left his job from a private sector IT Company. According to the service rule he is entitled for 35 days leave for each year of completed service. Here are the details about Mr A;

  1. Duration of service – 20 years
  2. Leave Availed while in service – Nil
  3. Leave at the credit of employee at the time of retirement (for the purpose of calculation of income tax) – 30*20 = 600days = 20 months
  4. Salary at the time of retirement Rs. 50, 000
  5. Average Salary received during last 10 months of employment – Rs. 40, 000
  6. leave salary received from employer – Rs. 4, 60,000

Calculation of leave salary for the purpose of income tax

Particulars Calculation in INR Eligibility in INR
Leave to the credit of employee at the time of retirement 20 months
Cash equivalent 20* 50,000 10, 00,000
10 months average salary 10*40, 000 4, 00,000
Maximum amount not chargeable to income tax 3, 00,000 3, 00,000
Amount received as leave salary from employer (assumption) 4, 60,000 4, 60,000
Amount not taxable as leave salary is the least of above 3, 00, 000
Taxable Amount 4, 60,000 – 3, 00,000 1, 60,000

FAQ

My father was working in a private sector company and he died during his service. His entire leave salary has been received by me. Will I be taxable under income tax act for this amount that I received due to my father’s death?

No, in your case the entire amount of leave salary you have received as a legal heir will be tax free and nothing will be taxable in your hand.

My mother who was working for a private organization retired from her job and now she is living with me in USA. As a part of retirement she has received Rs. 1, 00,000 as leave salary to the credit of her account with the employer. Please let me know if she has to pay income tax on such amount as she is not in India?

Yes, your mother is taxable as she has received leave salary with respect to the services she rendered in India. Even though she has received the amount in USA she has to pay income tax on this amount.

I am planning encashment of my leave salary pending with my present employer. Pleas let me know if this is taxable.

Yes, the entire amount will be taxable for you. Leave salary withdrawn during employment is taxable irrespective of your employer.

I am a retired employee and received leave salary of Rs, 2, 50,000. Please let me know under which head of income I need to pay income tax.

Leave salary after retirement will also be taxable under the head salary even though you are not in employment. In your case the entire amount of Rs. 2, 50,000 received will be taxable during the financial year under the head SALARY

2 thoughts on “Income Tax treatment of your leave encashment

    1. YFB

      It depends on your corporate policy. Based on your withdrawal income tax liability will be calculated. I will request you to check with your company on this.

      Reply

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