Government employees may not draw the hefty pay packets their counterparts in the private sector do. But then, they do enjoy some unique ‘neighbour’s envy, owner’s pride’ benefits.

One such goodie is the full tax exemption on the leave encashment they get on calling it quits from their jobs. This can translate into a tidy saving.

Say, on leaving her job after years of service, a government employee gets leave encashment of Rs.6 lakh. She gets to take home the entire sum. Had the amount been taxable, she would have been poorer by about Rs. 62,000 to Rs.185,000 depending on her tax slab.

Restrictions for some
Now, the taxman is kind to non-government employees too, but to a much lesser degree. For these lesser mortals, the tax break, according to Section 10 (10AA), is limited to the least of the following four sums:

a) amount actually received as leave encashment
b) amount prescribed by the government – Rs. 3 lakh
c) 10 months average salary based on Basic and Dearness Allowance in the 10 months before leaving the job, and
d) ash equivalent of the employee’s leave balance, subject to a maximum of 30 days for each completed year of service.

Here’s an example. Say, a non-government employee, according to her employment terms, is entitled to 45 days leave for each year of service. Over her 25 years of employment, she would have earned 1,125 days of leave of which she used 585 days; so the leave balance is 540 days (18 months).

The employer gives her ₹6 lakh as leave encashment. For tax exemption calculation though, the earned leave will be restricted to 30 days for each year of service; that’s 750 days. Deduct the 585 days leave taken and the leave balance will be just 165 days (5.5 months).

If the average monthly Basic plus Dearness Allowance in the 10 months before leaving service is Rs. 25,000, the tax exemption will be the least of the following amounts:

1) Rs. 6 lakh (amount received)
2) Rs. 3 lakh (amount prescribed by government)
3) Rs. 2.5 lakh (10 months average monthly salary of Rs. 25,000)
4) Rs. 1,37,500 (5.5 months * average monthly salary of Rs. 25,000).

Ergo: Of the Rs. 6 lakh received as leave encashment, just Rs. 1,37,500 will be exempt from tax. With the balance subject to tax, the take-home amount will be just about Rs. 3.2 lakh (in the 30 per cent tax slab) to Rs. 4.15 lakh (in the 10 per cent tax bracket). Not fair, you say. But such is life.

Available for resignation too
On the brighter side though, the tax exemption is not restricted to leave encashment on retirement. It is also applicable when an employee resigns from service.

Says Neha Malhotra, Manager, Nangia & Co, Chartered Accountants, “According to Section 10(10AA) of the Income tax Act, 1956, the word used is “retirement whether on superannuation or otherwise”.

Rulings by the Madras High Court (CIT vs RV Shahney) and the Bombay High Court (CIT vs DP Malhotra) emphasise on the word retirement which seen in the widest import covers resignation as per the legal thesaurus. This is definitely in favour of the assessee who can thus get the exemption benefits on voluntary retirement too.”

But note that the tax exemption limit of Rs. 3 lakh for non-government employees is an aggregate sum applicable across employers.

So, if you have already claimed Rs. 1 lakh as tax exemption on leave encashment when you left the services of an employer, you can claim only the remaining Rs. 2 lakh as tax breaks when you call it quits from future employers.

Even keel
There are some aspects though on which the tax authorities treat both government and non-government employees on an even keel.

So, if you encash the whole or part of your leave balance while continuing in the job, say at the end of each year, the amount is fully taxable. On the other hand, if the leave encashment amount is given to nominees or legal heirs on the death of the employee while in service, the amount is fully exempt.

Anand Kalyanaraman
This article was published on August 2, 2015, in BusinessLine (The Hindu)