Leave Encashment Tax Exemption under Section 10(10AA)
Section 10(10AA) of the Income-tax Act, 1961 provides an exemption for qualifying payments received in lieu of unused earned leave at retirement. The exemption depends on the category of employer and the amount received.
Meaning of leave encashment
Leave encashment is a cash payment made by an employer for earned leave accumulated but not used by an employee. It may be paid during employment or when employment ends. The tax treatment differs according to the time of payment and the employer category.
Section 10(10AA): legal provisions
Section 10(10AA)(i) - Government employees
The provision exempts cash equivalent of earned leave salary received by an employee of the Central Government or a State Government at retirement, whether on superannuation or otherwise. The qualifying amount is fully exempt.
Section 10(10AA)(ii) - Other employees
For employees other than Central or State Government employees, exemption is restricted to the lowest of the prescribed amounts, including the notified ceiling and the cash equivalent of eligible unused earned leave. Employees of private businesses, public sector undertakings and other non-qualifying employers generally fall within this category.
Read the official text of Section 10.
Eligible assessee and nature of income
| Particulars | Rule |
|---|---|
| Eligible assessee | Individual employee receiving qualifying leave encashment |
| Nature of income | Cash equivalent of accumulated earned leave salary |
| Government employee at retirement | Fully exempt under Section 10(10AA)(i) |
| Other employee at retirement | Exempt up to the lowest applicable limit under Section 10(10AA)(ii) |
| Encashment during continuing employment | Generally taxable as salary; retirement exemption does not ordinarily apply |
How to calculate exemption for non-government employees
The exempt amount is the lowest of the following four amounts:
- Actual leave encashment received at retirement.
- Cash equivalent of eligible unused earned leave at retirement, calculated using the average monthly salary.
- Ten months' average salary immediately preceding retirement.
- Rs. 25,00,000, reduced where applicable for exemptions claimed in earlier years.
For this calculation, earned leave entitlement is restricted to a maximum of 30 days for each completed year of service with the employer. The average monthly salary is based on the last ten months immediately preceding retirement and generally includes basic salary, dearness allowance to the extent it forms part of retirement benefits, and turnover-based commission.
Rs. 25 lakh exemption limit from 1 April 2023
CBDT Notification No. 31/2023 dated 24 May 2023 increased the notified ceiling for non-government salaried employees from Rs. 3 lakh to Rs. 25 lakh with effect from 1 April 2023. If qualifying payments are received from multiple employers in the same previous year, the aggregate exemption is subject to the overall limit. Exemptions allowed in earlier years also reduce the remaining available monetary ceiling.
Official sources: CBDT Notification No. 31/2023 and CBDT press release dated 25 May 2023.
Illustrative exemption calculation
Assume a private-sector employee retires and receives Rs. 12,00,000 as leave encashment. The average monthly eligible salary is Rs. 80,000 and the cash equivalent of eligible unused leave is Rs. 6,40,000. Assume no exemption was claimed in an earlier year.
| Calculation component | Amount |
|---|---|
| Actual payment received | Rs. 12,00,000 |
| Cash equivalent of eligible unused leave | Rs. 6,40,000 |
| Ten months' average salary | Rs. 8,00,000 |
| Notified ceiling | Rs. 25,00,000 |
| Exempt amount (lowest) | Rs. 6,40,000 |
| Taxable balance | Rs. 5,60,000 |
This is an illustration only; the actual computation depends on service history, leave records, salary components and earlier exemptions.
Other important conditions
- During service: Leave encashment received while employment continues is ordinarily taxable under the head Salaries.
- Retirement or separation: The statutory exemption applies to qualifying leave salary paid at retirement, whether on superannuation or otherwise.
- Death of employee: Payments to legal heirs require separate consideration of the facts and applicable tax treatment; do not automatically apply the employee's retirement formula.
- Tax regime: Section 10(10AA) exemption is generally available under both the old and new tax regimes, subject to eligibility.
- Documentation: Retain the employer's leave balance statement, final settlement, salary details and Form 16 for verification.
Frequently asked questions
Is leave encashment fully tax-free for private employees?
No. For a private or other non-government employee, the exemption is the lowest of the four prescribed amounts and may be less than Rs. 25 lakh.
Is leave encashment exempt for government employees?
Qualifying leave encashment received at retirement by Central or State Government employees is fully exempt under Section 10(10AA)(i).
Is the Rs. 25 lakh exemption available for payments before April 2023?
The enhanced notified ceiling applies from 1 April 2023. Earlier payments must be evaluated under the limits and law applicable at the relevant time.
Where can the exemption be checked while filing a return?
Review the salary and exempt income details in Form 16 and the relevant income-tax return schedules. The official Income Tax e-Filing portal provides return filing facilities and instructions.
Official references and further reading
- Income-tax Act, 1961 - Section 10(10AA)
- Income Tax Department - treatment of salary and retirement benefits
- Notification No. 31/2023 - Rs. 25 lakh ceiling
- Other exemptions under Section 10
- Tax-exempt income guide
Reviewed: 10 October 2026. This article explains Section 10(10AA) of the Income-tax Act, 1961 and the cited official guidance. Apply the law relevant to the tax year and facts of the case.