Section 10(10AA) — Leave Encashment Exemption
Section 10(10AA) of the Income Tax Act, 1961 exempts leave encashment received by an employee at the time of retirement or superannuation from income tax, with the ceiling for non-government employees enhanced to Rs 25 lakh by the Finance Act 2023.
Leave encashment refers to the payment made to an employee for accumulated earned leave that was not availed during employment, typically received at the time of retirement, resignation, or superannuation. Section 10(10AA) governs its tax treatment and draws a distinction between different categories of employees.
For central and state government employees, leave encashment received at the time of retirement is fully exempt from income tax with no monetary ceiling. This reflects the policy of providing comprehensive retirement security to government servants.
For non-government employees, the exemption was subject to an outdated ceiling of Rs 3 lakh, which had remained unchanged since 2002. Recognising this anomaly, the Finance Act 2023 enhanced the exemption ceiling to Rs 25 lakh with retrospective effect from 1 April 2023. This was a significant revision bringing the limit closer to the actual encashment amounts received by retiring employees in the private sector.
The exemption is calculated as the least of the actual leave encashment received, 10 months average salary (computed on the basis of the last 10 months average), cash equivalent of earned leave standing to the employee credit at the time of retirement (limited to 30 days per year of actual service rendered), or the statutory ceiling of Rs 25 lakh.
Leave encashment received during employment (i.e., when the employee is still in service and opts to encash accumulated leave) is fully taxable as salary income, regardless of the amount. The exemption under Section 10(10AA) is exclusively available at the time of retirement, superannuation, or death.
Where an employee receives leave encashment from more than one employer during service or at different times, the aggregate exemption is limited to the overall ceiling. The Finance Act 2023 amendment aligns the leave encashment exemption with the enhanced gratuity ceiling, creating a more balanced retirement income planning framework.