Understanding Section 10(10AA) of the Income Tax Act: Exemption for Leave Encashment

March 3, 2023

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Section 10(10AA) of the Income Tax Act, 1961 is a provision that offers relief to taxpayers on the taxability of specific types of leave encashment. The provision lays out the conditions under which leave encashment received by an employee can be exempt from tax. In this blog, we will discuss the details of Section 10(10AA) of the Income Tax Act, its applicability, and the conditions that need to be satisfied to claim the exemption.

Table of Contents

What is Section 10(10AA) of Income Tax Act?

Section 10(10AA) of the Income Tax Act states that any payment received by an employee in lieu of leave period not availed by them can be exempt from tax to a certain extent. The provision applies to leave encashment received by an employee at the time of retirement, resignation, or termination of employment. The exemption is subject to certain conditions.

Applicability of Section 10(10AA)

The provision applies to all salaried individuals who receive leave encashment from their employer. The provision is applicable to both government and private sector employees.

Conditions for claiming exemption under Section 10(10AA)

To claim exemption under Section 10(10AA), the following conditions need to be satisfied:

Leave encashment must be received at the time of retirement, resignation, or termination of employment.
The exemption is limited to a maximum of Rs. 3,00,000.
The leave encashment amount should be received in respect of the period of earned leave standing to the credit of the employee at the time of retirement, resignation or termination of employment.
The exemption is available only to the extent that the leave encashment amount is actually received by the employee and not to the extent that it is due or accrued to the employee.
The employee should have rendered continuous service for a minimum period of 10 years.
The exemption is available only for the leave earned during the period of service.

Calculation of exemption under Section 10(10AA)

The amount of exemption available under Section 10(10AA) is calculated based on the following formula:

Least of the following is exempt:

Actual amount received as leave encashment
Maximum amount specified by the government, which is currently Rs. 3,00,000
Cash equivalent of the leave balance, calculated as per the formula: (last drawn salary x no. of days of earned leave) / 30

While Section 10(10AA) of the Income Tax Act provides relief to taxpayers on the taxability of leave encashment, it is essential to note that there are certain situations where the exemption under this provision may not be available. Let us discuss some of these situations:

Resignation or Termination before Completion of 10 Years of Continuous Service: If an employee resigns or is terminated from their employment before completing 10 years of continuous service, the exemption under Section 10(10AA) will not be available.
Leave Encashment for Privilege Leave: Section 10(10AA) only provides an exemption for the leave encashment of earned leave, which is also known as casual leave. It does not cover privilege leave, which is leave granted to employees as a part of their service conditions.
Leave Encashment for Unused Sick Leave: The exemption under Section 10(10AA) is not available for the encashment of unused sick leave.
Leave Encashment for Unavailed Leave During Service: Section 10(10AA) is applicable only to the leave encashed at the time of retirement, resignation or termination of employment. The exemption is not available for leave encashed during the period of employment.

Apart from the general conditions for claiming exemption under Section 10(10AA) of the Income Tax Act, there are a few additional points that taxpayers should keep in mind. Let’s take a look at some of these points:

Taxability of Excess Leave Encashment: If the amount of leave encashment received by an employee exceeds the maximum limit of Rs. 3,00,000, the excess amount will be taxable as per the applicable tax rate.
Taxability of Leave Encashment in Case of Deceased Employees: In case of the demise of an employee, the leave encashment amount received by their legal heir or nominee will be taxable as per the applicable tax rate.
Taxability of Leave Encashment in Case of Retirement: The leave encashment received by an employee at the time of retirement is taxed as salary income in the financial year in which it is received.
Taxability of Leave Encashment in Case of Resignation or Termination: The leave encashment received by an employee on account of resignation or termination is taxed as “profits in lieu of salary” in the financial year in which it is received.
Exemption for Government Employees: The maximum limit of Rs. 3,00,000 for exemption under Section 10(10AA) is applicable to both government and private sector employees.

It is important for taxpayers to keep these additional points in mind while claiming exemption under Section 10(10AA) of the Income Tax Act.

Conclusion

In conclusion, Section 10(10AA) of the Income Tax Act, 1961 provides relief to salaried individuals on the taxability of leave encashment received by them. The provision applies to all salaried individuals who receive leave encashment from their employer, subject to certain conditions. The exemption is limited to a maximum of Rs. 3,00,000 and is calculated based on the actual amount received as leave encashment, the maximum amount specified by the government, or the cash equivalent of the leave balance. It is essential for taxpayers to understand the conditions for claiming exemption under Section 10(10AA) to avoid any tax-related issues in the future.

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Frequently Asked Questions (FAQs)

What is Section 10(10AA) of the Income Tax Act?

Section 10(10AA) of the Income Tax Act provides an exemption for leave encashment received by employees at the time of retirement, resignation, or termination of employment.

2. What is the maximum limit of exemption under Section 10(10AA)?
The maximum limit of exemption under Section 10(10AA) is Rs. 3,00,000.

3. Is the exemption under Section 10(10AA) available for all types of leave?
No, the exemption under Section 10(10AA) is available only for the encashment of earned or casual leave, not for privilege leave or sick leave.

4. Is the exemption under Section 10(10AA) available for all employees?
No, the exemption under Section 10(10AA) is available only to employees who have completed at least 10 years of continuous service with their employer.

5. Is the exemption under Section 10(10AA) available for government employees?
Yes, the exemption under Section 10(10AA) is available for both government and private sector employees.

6. Is the exemption under Section 10(10AA) available for encashment of leave during employment?
No, the exemption under Section 10(10AA) is available only for leave encashed at the time of retirement, resignation, or termination of employment.

7. Is the excess amount of leave encashment taxable under Section 10(10AA)?
Yes, if the amount of leave encashment received by an employee exceeds Rs. 3,00,000, the excess amount is taxable as per the applicable tax rate.

8. How is the leave encashment amount taxed in case of retirement?
The leave encashment amount received by an employee at the time of retirement is taxed as salary income in the financial year in which it is received.

9. How is the leave encashment amount taxed in case of resignation or termination?
The leave encashment amount received by an employee on account of resignation or termination is taxed as “profits in lieu of salary” in the financial year in which it is received.

10. Is the leave encashment amount received by the legal heir or nominee of a deceased employee taxable?
Yes, the leave encashment amount received by the legal heir or nominee of a deceased employee is taxable as per the applicable tax rate.