Every employee is entitled to avail certain number of leave per annum as decided by an organization. But, if such leave is not utilized, then unutilized leave is either get lapsed or get carry forward. Leave Salary or Leave Encashment is simply the amount payable for the employee’s leave period, depending upon the leaves to his credit.

Leave Salary /Encashment received during the employment

Fully taxable under “Income from Salary”, in hands of both the Government and Non-government employees. However, benefit of relief is availed u/s 89(1).

Leave Salary /Encashment received on retirement or on death

Government Employees: Exempt from tax whether received on retirement or on death.

Non Government Employees: 

• Received on retirement – Taxable under the head Salary.
• Received by legal heirs on death – Taxable under the head other sources.

However, in both cases amount received is exempt u/s 10(10AA) as under:

Least of the following is exempt.

1. Amount actually received.
2. Last 10 months average salary.
3. Cash equivalent of leaves available in one’s account (leave balance) (not exceeding 30 days per year of actual service)
4. Maximum limit Rs. 3, 00,000.

Other Relevant Points:

• Average Salary is on the basis of average salary drawn during the period of 10 months immediately preceding the retirement or superannuation.
• Salary:  Basic salary + Dearness Allowance + Commission based on a fixed % of turnover.
• The limit of Rs. 3,00,000 is a lifetime limit, so if resignation from different jobs occurs at different times, total exemption is limited to Rs. 3,00,000.
• The amount of TDS is deducted while receiving leave Salary.

The above can be well understood with an Example:

Mr. X retires from ABC private sector on Feb 28, 2011. Salary at the time of retirement is Rs.30,000 & Leave salary received is 30,000 p.m. Average salary of 10 months is Rs.20, 000. Duration of service is 24 years. Leave availed is 19 months & leave at the credit of employee is 17 months. Determine the exempt amount of Leave Salary ?

SOLUTION:

Least of the following is exempt:

1. Amount actually received (30,000*17)                        5,10,000
2. 10 months average salary                                          2,00,000
3. Gross Leave Entitlement [30,000*(24-19)]                 1,50,000
4. Maximum Limit                                                            3,00,000

So, amount of Rs. 1,50,000 is exempt whereas amount of Rs. 3,60,000 is taxable under the head “Income from Salary”.