The finance ministry has issued a notification dated May 24, 2023, in line with the budget 2023 proposal, to announce an increased ceiling for the encashment of earned leave exempt from income tax. This change will be implemented from April 1, 2023.
Following the powers granted by sub-clause (ii) of clause (10AA) of section 10 of the Income Tax Act, 1961 (43 of 1961), the Central Government has specified the maximum amount of Rs. 25,00,000 (twenty-five lakhs rupees only) as the limit for employees covered under that sub-clause who retire, whether through superannuation or otherwise. This determination takes into consideration the cash equivalent of leave salary receivable by employees based on their accumulated earned leave at the time of retirement.
The finance ministry circular emphasises that this notification is deemed effective from April 1, 2023.
This measure brings positive news for employees in the non-government sector, as it entails an increase in tax exemptions for leave encashment payments related to accumulated leave balances over time.
During her budget speech, Finance Minister Nirmala Sitharaman highlighted that the existing limit of Rs. 3 lakhs for tax exemption on leave encashment for non-government salaried employees upon retirement was set in 2002 when the highest basic pay in the government was Rs. 30,000 per month. In view of the subsequent rise in government salaries, she proposed raising this limit to Rs. 25 lakhs.
Encashment of Leave Balances
Regarding leave encashment, it is important to note that in the private sector, such payments received after retirement or resignation are taxable as “income from salary.” However, individuals can claim exemptions under Section 10 (10AA)(ii) of the Income Tax Act.
As per the provisions of Section 10(10AA)(ii), the exemption for leave encashment is limited to the least of the mentioned amounts, which has now been increased to Rs. 25 lakhs from the previous limit of Rs. 3 lakhs:
According to the Income Tax website, these rules apply specifically to non-government employees, excluding Central or State Government employees. Leave salary excluded from income tax liability under Section 10(10AA)(ii) will be least of the following-
- Period of earned leaves in months (*) * the average monthly salary (**)
- Average monthly salary () * 10 (i.e., 10 months average salary)
- The maximum amount specified by the Central Government is currently set at Rs. 3,00,000. Different amounts (i.e., ceiling limits) are specified by the government for different years.
- Leave encashment actually received upon retirement.
