“TAXATION OF LEAVE SALARY/LEAVE ENCASHMENT”

TAX TALK-29.04.2013-THE HITAVADA

TAX TALK  

BY CA. NARESH JAKHOTIA

Chartered Accountant

“TAXATION OF LEAVE SALARY/LEAVE ENCASHMENT”

Query 1]

I have a query on exemption of leave encashment. I request you to please clarify on the same through Tax-Talk column. I have retired on 28^th February 2013 from the Post of Executive Engineer from Maharashtra State Electricity Transmission Company limited, a wholly owned corporate entity under the Maharashtra Government, which  was incorporated under the Companies Act, in June, 2005 after restructuring the erstwhile Maharashtra State Electricity Board. I understand that the employees of Central Government as well as the State Government are allowed accumulation of earned leave up to 300 days and are fully exempt from payment of Income Tax on encashment of leave to his credit at the time of superannuation. All other employees of private sector are allowed exemption up to a limit of Rs. 3 Lacs from payment of tax.

I am likely to get around Rs. 10 Lacs as amount of leave encashment. Therefore the tax exemption depends on the factor whether employees of MSETC which is a wholly owned corporate entity under the Maharashtra Government are treated as State Government employee or not. My queries are:  

1.      Whether being an employee of a wholly owned corporate entity under State Government, I come under the category of State Government Employee? Whether there are any guidelines issued under the I.T. Act to define a Government employee? and

2.      I have retired on 28^th February 2013. If the amount of leave encashment [which shall be around Rs. Ten Lacs] is received and deposited in Bank after 1^st April 2013, may I treat the leave encashment income as income for the financial year 2013-14? In other word whether this amount should be accounted for on accrual basis or actual receipt basis? Please guide elaborately.  [Shankarlal Meghani - gopalvan@sify.com]

Opinion:

Before stepping up to your query, let us have a look at the basic provision related to taxability of leave salary. Leave salary, also known as leave encashment, means that employee will receive the cash for leaves which are not taken by the employees. The leave encashment received during the service period is taxable for all the employees as per the income tax slab applicable to the employee. However, the tax treatment is different for the leave encashment received at the time of retirement/ superannuation. Further, the tax treatment is different for Government employee (Central or State) vis a vis  Non –Government employee as under:  

·        In the case of Central/ State Government employee, any amount received as cash equivalent of leave salary in respect of period of earned leave at his credit at the time of retirement/ superannuation is fully exempt from tax u/s 10(10AA)(i). 

·        In the case of Non-Government employee (i.e., the employee other than an employee of the Central Government or a State Government) leave salary is exempt from the tax u/s 10(10AA) (ii) to the extent of the least of the following:
i] Cash equivalent of the leave salary in respect of the period of earned leave to the credit of an employee only at the time of retirement whether on superannuation or otherwise (earned leave entitlement cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired): or
ii] 10 month “Average Salary” or
iii] The amount not chargeable to tax as specified by the Government. (Presently, Rs. 3 Lacs has been specified).
iv] Leave encashment actually received at the time of retirement.
Average salary, as mentioned above, is to be calculated on the basis of average salary during the period of 10 months immediately preceding the retirement/ superannuation.
”Salary” here means basic salary & includes dearness allowances if term of employment so provided. It also includes commission based on a fixed percentage of turnover achieved by an employee as per term of contract of employment but excludes all other allowances & perquisites.

Now, with above basic brief up about taxability of leave salary, the opinions on the issue raised in your queries are as under:

1.      Leave salary received at the time of retirement is exempt only in the hands of State or Central Government employee. It will not be exempt in the hands of the employee of PSU or Local Authorities. The definition of “Government Employee” is not specifically given in the Income Tax Act-1961. However, the Act has specifically incorporated the PSU employees, Government undertaking employee, Local Authorities employees etc in various other Sections / clauses in the Income Tax Act-1961 where the benefit is meant to be conferred to them. The same is not there in Section 10(10AA).

2.      The Leave Salary is taxable under the head “Income from Salary”. The Salary Income is taxable in the year in which it has accrued or in the year in which it is received, whichever is earlier. Accordingly, the leave encashment is taxable as income of the FY 2012-13 and not FY 2013-14.

TAXABILITY OF LEAVE SALARY AT A GLANCE:

S.No.	Particulars	Tax Treatment
A]	Encashment of leave during service	It is charged to tax.
B]	Encashment of leave at the time of retirement
	1. If Central or State Government Employees	Fully exempt from tax u/s 10(10AA)(i)
	2. For any other employees	Lease of the following is exempt: 1. Earned leave months x Average salary 2. Avg. monthly salary x 10 3. Maximum amount Rs. 3,00,000/- 4. Actually received