LEAVE ENCASHMENT AT THE TIME OF RETIREMENT: TAXATION & PLANNING

 

One of the components received by the employee at the time of retirement is “Leave Encashment”. Let us know about the income tax implication of the amount received at the time of retirement.

It may be noted that the payment received on account of encashment of unavailed leave would form part of “Salary” and will be taxable under the head “income from Salary”.

Leave salary encased during the period of service is fully taxable. However, section (10)(10AA) of the Income Tax Act provides certain relaxations from tax to amounts received on account of unutilised leaves during retirement.

The tax provisions related to the exemption taxation of Leave encashment are as under:

Nature of Employee	Treatment of Unutilised Leaves Encashed on Retirement, whether on Superannuation or Otherwise
Government employees	Fully exempt from tax
Non-government employees	Exempt from tax to the extent of least of the following: Three lakh rupees Leave salary actually received 10 months’ salary (on the basis of average salary of last 10 months) Cash equivalent of leaves left with the employee (based on last 10 months’ average salary) at the time of retirement or death. [Salary for this purpose means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits and commission which is expressed as a fixed percentage of turnover.]

There are few important points which must be noted while working out the tax implications of the same:

1. It should be noted that earned leave entitlement cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired.

1. Salary for this purpose means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits and commission which is expressed as a fixed percentage of turnover.

2. If the leave is encashed during employment, the entire amount is taxable under the head “Income from salary”. One can still opt for exemption when filling for returns.

3. There are the cases where leave salary is received from two or more employers in the same year, then the aggregate amount of leave salary exempt from tax cannot exceed three lakh rupees. Additionally, where leave salary is received in any earlier year from a former employer and again received from the new employer in a later year, the limit of three lakh rupees will be reduced by the amount of leave salary exempt earlier.

4. The planning for retirement has to be based on the various other factors like liquidity needs, retirement goals, cost of inflation, time value of money, etc. so as to make an informed decision

5. As a tax planning measure, it is always advisable to encash unutilised leaves annually on a systematic basis or receive a lump sum amount at the time of retirement or resignation.