Leave encashment taxability often confuses employees and HR teams alike. Recently, the Income Tax Appellate Tribunal (ITAT) clarified that the taxability of employee leave encashment must be examined separately for government and non-government employees. Here’s a simplified guide to help you comply smartly.
What is Leave Encashment?
- Money paid by employer for unused leave days.
- During service
- At retirement/resignation
How Leave Encashment is Taxed
| Aspect | Govt Employee | Non-Govt Employee |
|---|---|---|
| During Service | Fully taxable | Fully taxable |
| At Retirement | Fully exempt under Section 10(10AA)(i) | Partly exempt under Section 10(10AA)(ii) |
Key Legal References
- Section 10(10AA) of Income Tax Act, 1961
- CBDT Circular No. 309 dated 03-07-1981
- Latest ITAT ruling: [ABC Ltd. vs ITO, 2024] clarifies separate treatment for Govt vs Non-Govt staff.
Exemption Limits for Non-Govt Employees
Excess is taxable as salary income.
Expert Tip: Plan Leave Encashment
- Use leave balances periodically to avoid large taxable lumpsums.
- Check your employer’s leave encashment policy to align with tax rules.
- Maintain records of leave earned and encashed.
ITAT’s Key Observation
The ITAT held that clubs or companies run by government bodies do not automatically qualify employees as Govt employees.
FAQs on Leave Encashment
Is leave encashment taxable every year?
Yes, if encashed during service, it is fully taxable every year.
Can Govt employees claim full exemption?
Yes, if they retire from a Govt department or PSU explicitly treated as such.
How to report leave encashment in ITR?
Declare under ‘Salary Income’. Exempt portion under ‘Exempt Income’.
Summary for Quick Reference
Taxability of employee leave encashment depends on your employment type. Govt employees enjoy full exemption on retirement; others get partial relief up to a limit. Plan ahead and consult your CA to avoid surprise tax bills.
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