LEAVE ENCASHMENT OR LEAVE SALARY (F.Y.2016-17):- When any employee does not avail his/her leaves as per terms of employment then he/she gets the salary in lieu of non-availed leaves. This type of payment is called leave encashment. As per Indian Income Tax Act, the leave encashment is exempt from income tax subject to the following conditions:-

  1. In case of Central Government or State Government employees, whole amount of leave encashment is exempted from income tax.
  2. In case of any other employee, the least of the following amount shall be exempted from income tax:-
  • Actual amount of leave encashment received
  • Cash equivalent of earned leave (not exceeding 30 days for each year of service) at his credit on retirement.
  • Ten months average salary i.e. ten times the average of salary drawn during ten months preceding his/her retirement or
  • Rs.3,00,000/= (Rupees three lacs).

Notes:-

  1. Leave encashment is exempt from income tax only if it is received at the time of retirement only.
  2. Leave availed during the service period is taxable whether it is availed at the time of LTC or otherwise.
  3. Receipt of leave encashment of privilege leave standing to the credit of the employees received by the legal heirs of a deceased employee is exempt from income tax.
  4. When the employees receives the leave encashment from more than one employer in previous year or more previous years, the maximum amount of exemption will not exceed the monetary limit as specified above i.e. three lacs as reduced by the amount which has already been exempted from income tax in the same previous year or earlier previous year or years.
  5. Salary for this purpose includes Dearness Allowance but excludes other allowances and perquisites.

Illustration:

Mr. X is a non-government employee. He retired on 31.12.2016. He got leave encashment for Rs. 6,00,000/=. Other information are given as under:-

  • Basic Salary since 2014 Rs.20000/=
  • Total duration of Service period 30 years
  • Leave credit to his account at the time of retirement 20 months
  • Leave entitlement for every year of service 45 days.
  • Leave availed while in service 15 months.

Calculate his taxable income from leave encashment for financial year 2016-17 ?

Solution:

  • Leave encashment actually received Rs.6,00,000/=
  • Entitlement of leaves as per income tax act for exemption purpose 30 days for each completed year of service i.e. 30 x 30 days  = 30 months.
  • Leave availed during service period = 20 months
  • Leaves available for encashment (30-20) 10 months
  • Average monthly salary is Rs.20,000/=
  • Cash equivalent of leave = 20000 x 10  = Rs. 2,00,000/=
  • Ten months average salary = 20000 x 10 = Rs.2,00,000/=
  • Maximum monetary limit is Rs.3,00,000/=
  • Amount received as leave encashment Rs.600000/=
  • Maximum amount allowed as exemption Rs.200000/=
  • Taxable amount from leave encashment (600000 minus 200000) Rs.4,00,000/=

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