Explained: What is the new Tax-Free Leave Encashment Limit

Tax-Free Leave Encashment: In the Union Budget 2023-24 a new benefit for retired salaried employees rises. A new tax-free limit for leave encashment now allows people to claim up to ₹25 lakhs in the exemption, which has increased from the previous limit of ₹3 lakhs. Read further to know more. 

CBDT issues Notification No.31/2023 dt 24.05.2023 increasing limit for tax exemption on leave encashment for non-government salaried employees to Rs.25 lakh w.e.f. 01.04.2023.

For more details, please see the Press Release:https://t.co/OUHr07xTCZ pic.twitter.com/8T24BjCL23

— Income Tax India (@IncomeTaxIndia) May 25, 2023

What is Tax-Free Leave Encashment? 

Leave encashment that is received after retirement or resignation is considered taxable income under the "Income from Salary" category. However, employees can easily claim an exemption from this tax under Section 10 (10AA) of the Income-Tax Act.

The government allows many benefits to employees, including tax-free leave encashment. This policy allows salaried employees to encash their leaves at the time of their retirement or resignation without paying any income tax on the amount they are encashing. The amount that can be encashed tax-free is capped at a certain limit. 

The previous Tax-Free Limit for Leave Encashment was set at ₹3 Lakhs per person. According to the Income Tax Act “As per section 10(10AA), leave encashment by a Government employee at the time of retirement (whether on superannuation or otherwise) is exempt from tax. 

In the hands of non-Government employee exemption will be least of the following:

• Period of earned leave standing to the credit in the employee’s account at the time of retirement (*) × Average monthly salary ($).
• Average monthly salary ($) × 10 (i.e., 10 months’ average salary).
• Maximum amount as specified by the Government, i.e., Rs. 3,00,000.
• Leave encashment actually received at the time of retirement.”

When was the new Limit announced? 

The new opportunity of the enhanced tax-free leave encashment limit was announced in the Union Budget 2023-24 on May 25, 2023, by Finance Minister Nirmala Sitharaman. The increase in the limit was made in line with the increase in government salaries.

The announcement was made in May, 2023 however, the new tax-free leave encashment limit of ₹25 lakh becomes effective from April 1, 2023. This means that salaried employees who retire after March 31, 2023, will be eligible for the new tax exemption.

What is the eligibility for the new Tax-Free Leave Encashment Limit?

Every government is exempt from the tax however for the non-government employee, the tax-free leave encashment limit is as follows according to the Income Tax Department: 

“In the hands of non-Government employee exemption will be least of the following:

• Period of earned leave standing to the credit in the employee’s account at the time of retirement (*) × Average monthly salary ($).

• Average monthly salary ($) × 10 (i.e., 10 months’ average salary).

• Maximum amount as specified by the Government, i.e., Rs. 3,00,000.

• Leave encashment actually received at the time of retirement.

• (*)Leave credit to the account of the employee at the time of retirement should be restricted to 30 [As amended by Finance Act, 2023] days per year of service if leave entitlement as per service rules exceeds 30 days per year of actual service.

• ($) Salary for the above purpose means average salary drawn in the past ten months immediately preceding the retirement (i.e., preceding the day of retirement) and will include basic salary, dearness allowance (if considered for computing all the retirement benefits) and commission based on fixed percentage of turnover achieved by the employee.
• Apart from the above items, salary for this purpose does not include any other allowances or perquisites."

The new tax limit on leave encashment is a welcome relief for non-government salaried employees. It will help them to save on their tax liability and boost their retirement savings. The new limit is also in line with the general increase in income from salary.