Most organizations provide casual leaves, medical leaves and gazette holidays to their employees every year. On the off chance an employee fails to avail a few chunks of these leaves, they can be transferred to the following year. Another option is to apply for encashment of such leaves. The cashed-in amount can be earned through salary disbursement. Of course, this is conditional on how many days of leave encashment does the employee opt for.
When an employee receives the encashment amount, it’s treated as the salary. As a consequence, the leave encashment amount would be considered as a form of taxable income. In a few income tax provisions, leave encashment in India offers the benefit to the taxpayer of exemption from the tax liability.
How to calculate the taxability of leave encashment?
The exempted amount is deducted from the sum of money received from encashment.With intent to compute income tax, employees belonging to the following are considered namely,
- Government employees
- Non-Government employees
If both these types of employees fulfill the condition of continual service, the leave benefit payments can be availed during the service tenure and income tax relief can be appealed under section 89.
Section 89 of the Income Tax Act
This comprises of provisions that allow a taxpayer to claim dispensation to receive salary arrears/advance, gratuity, compensation on the assumption that the employee was terminated and payment pertaining to the commutation of pension.
It’s to be noted that in the event of the death of an individual, the leave encashment rendered to the bereaved family members is absolved from any tax deduction.
In the event of retirement or in case of resignation from the job, the actuarial valuation of leave encashment and the applicable tax exemption criteria are described below.
- The dole of leave encashment is sanctioned to a government employee. This amount, although falls under the Income Tax Act, yet it’s fully exempted from tax liability under section 10 (10AA) (i).
- By the same token, the non-government employees are also eligible for this benefit. Here also, the amount is tax deductible and either partially or fully free from deduction based on specific cases as per section 10 (10AA) (ii).
- In the case of a non-government
employee, at the time of retirement, leave encashment calculation
of the accumulated leaves will be contingent on the following stipulations.
- A cash payout equivalent to the number of not availed leaves based on a maximum one month leave period every year during the time the service is rendered.
- A fixed amount designated by the Government equal to 10 times the average monthly salary.
- The exact amount of leave encashment actually received after retirement.
- The leave encashment calculation is done on the basis of the final withdrawn salary. This includes the basic pay, medical allowance, dearness allowance, personal pay (applicable to allowances doled out to non-practicing doctors), allowances pertaining to Enhanced Disability Premium (EDP) and other staffs from the finance and accounts department.
The benefits dispensed with leave encashment are exclusive of salary/wage for overtime, PF, Gratuity, Performance Bonus etc.