Budget 2023: Non-government employees to enjoy tax exemption on leave encashment

Since 2002, the limit for tax exemption on leave encashment was Rs 3 lakh for non-government salaried employees. Budget 2023 announced a big jump in this limit, making it reach Rs 25 lakh.

Leave Encashment Limit

On 1 February 2023, the Finance Minister announced new leave encashment exemptions for non-government employees. The proposed amendment saw a big jump in the leave encashment limit, reaching up to Rs 25 lakh from the earlier limit of Rs 3 lakh. 

What is the leave encashment limit?

A salaried employee is entitled to a minimum number of paid leaves annually. But it is not necessary that the individual employee uses all the entitled leaves. Most employers give employees the option to carry forward such unutilised paid leaves. 

Consequently, the employee accumulates an unused leave balance by the time of resignation or retirement from the company. This makes the employer compensate the employees’ paid leave balance. This concept is known as leave encashment.

Leave encashment is taxable according to the law. Taxpayers must include the amount under the head for ‘income from salary.’ However, individuals can claim an exemption under Section 10 (10AA) (ii) of the Income Tax Act 1961. Before the amendments announced in the Union Budget 2023, the tax-exempt limit on leave salary was Rs 3 lakh. This amount for tax exemption on leave salary on the resignation or retirement of non-government staff was last defined in 2002 when the highest basic pay was Rs. 30,000 per month.

This limit, known as the leave encashment limit, has now been incremented to Rs 25 lakh, in line with the increase in government salaries.

Also Read: Full And Final Settlements That Need To Be Done When Leaving Your Company

How to calculate the tax exemption on leave encashment?

When a taxpayer receives leave encashment on leaving a job or retirement, the payment shall be exempt up to the least of the following amounts under Section 10 (10AA) (ii).

  1. Average monthly salary for ten months.
  2. Average monthly salary x period of earned leave in months.
  3. Leave encashment limit as proposed by the Central Government.
  4. Payment received as leave encashment at the time of retirement.

Please note the average monthly salary refers to the average salary earned in the past ten months immediately preceding retirement.

The Income Tax Department’s website recognises any individual working in a private or public company other than in the Central or State Government as a non-government employee. The limit of tax exemption on leave encashment for these non-government employees has been increased to Rs 25 lakh from Rs 3 lakh. The proposal would benefit lakhs of employees to save their capital.

Also Read: All You Need To Know About Leave Travel Allowance (LTA)

Impact of the increase in leave encashment limit on employees

The decision to exempt leave salary from tax is favourable for non-government employees. Higher tax exemptions for leave encashment earned against unutilised leaves over the years mean more savings for taxpayers. The government’s move also aids in retirement planning.



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