India Increases Tax Exemption Limit on Leave Encashment for Private Sector Employees

Posted by Written by Naina Bhardwaj Reading Time: 4 minutes

India has increased the tax exemption limit on leave encashment for employees in non-government sectors, that is, private sector organizations. The new tax-exempt limit is INR 2.5 million, which reflects the higher average earnings. Organizations should note the changes to their payroll as the new tax rule will be retrospectively implemented from April 1, 2023.

India’s federal government recently issued a notification announcing an increased limit for tax exemption on earned leave encashment for non-government (private sector) salaried employees, in line with the budget proposal for the financial year (FY) 2023-24. Finance Minister Nirmala Sitharaman highlighted the need to update the existing limit of INR 300,000, which was set in 2002 and is no longer in line with current salary scales. The proposed limit has been raised to INR 2.5 million (approximately US$30,306), and it will be applicable retrospectively from April 1, 2023. (US$1 = INR 82.49.)

The government has assured that the retrospective implementation of this notification will not have any adverse impact on individuals.

FAQs on India’s updated leave encashment policy

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What is the process of leave encashment as per India’s labor laws?

India Tax Guide 2023-24Under the labor laws, leave encashment involves the employer compensating employees for their accumulated unutilized paid leave balance. Salaried individuals are entitled to a minimum number of paid leaves annually. If employees don’t utilize all their entitled leaves within a year, they may be allowed to carry forward the unused leaves. Upon retirement or resignation, employees receive compensation for the unutilized leave, which is known as leave encashment.

When will the new limit for tax exemption on earned leave encashment come into effect?

The new limit will be applicable from April 1, 2023, onwards. Individuals retiring on or after this date will benefit from the increased limit.

Will the new limit apply to both the old and new income tax regimes?

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Yes, the enhanced limit for tax exemption on earned leave encashment will be applicable in both the old and new income tax regimes.

Are there any restrictions on the total amount exempted from tax for non-government employees receiving leave encashment from multiple employers?

The total amount exempt from tax will not exceed INR 2.5 million if a non-government employee receives such payments from multiple employers in the same previous year. Additionally, the exempted amount will not surpass INR 2.5 million after considering the tax exemption already granted under section 10(10AA)(ii) of the Income-tax Act, 1961 in previous years.

Is leave encashment taxable? If yes, how can individuals claim tax benefits?

  • Leave encashment received during service: Leave encashment is taxable based on when it is received. If received while still employed, the amount is fully taxable as “income from salary.” However, individuals can claim tax benefits under Section 89 of the Income-tax Act by filling out Form 10E to request relief for leave encashment. This form can be submitted online through the income tax portal.
  • Leave encashment at retirement or resignation: The taxation of leave encashment received at retirement or resignation depends on the employee’s category.
    • State and Central government employees: Leave encashment received by government employees is fully tax-exempt.
    • Non-government employees: For non-government employees, leave encashment is partly exempt and partly taxable. The exemption calculation follows the guidelines specified in Section 10(10AA)(ii) of the Income-tax Act.
    • Legal heir of a deceased employee: Leave encashment received by the legal heir of a deceased employee is fully tax-exempt.

What is the formula to calculate leave encashment?

The leave encashment formula is: [(Basic Salary + Dearness Allowance) / 30] * Number of earned leaves.

What are the various types of leaves commonly provided to employees?

Employees are typically entitled to different types of leaves, including:

  • Casual leave: Granted for personal reasons and usually spans 7 to 10 days. The policy for encashing casual leave varies among companies.
  • Earned leave or privilege leave: Employees can take earned leaves after providing prior notice to the organization. These leaves become eligible for encashment after a specific period, which differs based on the organization’s policy.
  • Medical leave: Available when employees are unable to work due to health conditions. The maximum limit for medical leaves varies between companies.
  • Holiday leave: Provided by employers without any deduction from the salary. The maximum number of holiday leaves allowed may differ across companies.
  • Maternity leave: The Maternity Benefit Act, 1961, entitles female employees to maternity leave. The current provision allows for up to 26 weeks of maternity leave, with at least eight weeks to be taken before the expected delivery date. Organizations with more than 10 employees are required to provide maternity benefits. The additional period beyond 26 weeks may be unpaid and is not eligible for encashment.
  • Sabbaticals: Leaves granted to employees for skill enhancement and knowledge development. Employers may reimburse sabbatical leaves if employees are enrolled in courses or pursue upskilling opportunities. These also depend on company policy.

While there are legal provisions and guidelines for certain types of leaves, such as maternity leave, it’s essential to understand that the policies regarding leaves in private organizations can vary. Employees should consult their company’s leave policy or employee handbook to obtain comprehensive information about each type of leave and its specific terms and conditions.

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