Tax exemption limit on leave encashment increased to Rs 25 lakh for non-government salaried employee

The finance ministry has issued a notification on May 24, 2023, to implement the increased ceiling for encashment of earned leave exempt from income tax. This change is in accordance with the proposal outlined in the budget for 2023. The new ceiling will be effective from April 1, 2023.

The notification refers to sub-clause (ii) of clause (10AA) of section 10 of the Income-tax Act, 1961, which grants exemption for cash equivalent of leave salary received by employees upon retirement, whether due to superannuation or otherwise. The Central Government, considering the maximum amount receivable by its employees as cash equivalent of leave salary at the time of retirement, has specified the new limit of Rs. 25,00,000 (twenty-five lakhs rupees only).

According to the circular issued by the finance ministry, this notification is deemed to have come into force on April 1, 2023.

Yes, the increased ceiling for tax exemption on leave encashment is indeed a positive development for non-government employees. The previous limit of Rs. 3 lakh for tax exemption on leave encashment was last set in 2002, when the highest basic pay in the government was Rs. 30,000 per month. However, considering the subsequent increase in government salaries, Finance Minister Nirmala Sitharaman announced in her Budget speech that the limit would be raised to Rs. 25 lakh. This adjustment aligns the tax exemption limit with the changing income levels of employees over time, benefiting non-government salaried individuals upon their retirement.

That's correct. In the private sector, the leave encashment received after retirement or resignation is considered as "Income from Salary" and is taxable. However, individuals can claim an exemption under Section 10(10AA)(ii) of the Income-tax Act.

As per the Income tax website, “In case of non-Government employees (i.e., other than the Central or the State Government employees), leave salary exempt from tax under section 10(10AA) (ii) will be least of the following:

1. Period of earned leave in months (*) × Average monthly salary (**)

2. Average monthly salary (**) × 10 (i.e., 10 months’ average salary)

3. Maximum amount as specified by the Central Government i.e., Rs. 3,00,000 Different amounts (i.e., ceiling limits) are specified by the Government for different years.

4. Leave encashment actually received at the time of retirement.”