Mr Chhaju worked at State Bank of India in Murlipura Scheme, Jaipur. When he retired in 2020, he received Rs 9.53 lakh as leave encashment. He tried to claim a full tax exemption on this amount under Section 10(10AA). However, this created a problem with income tax authorities.
Bank employees, whether from nationalised or private sector banks, could claim only Rs 3 lakh tax exemption on leave encashment if they retired before 2023. From 2023, the limit has been enhanced to Rs 25 lakh.
Nationalised bank employees are not government employees and cannot claim full tax exemption on leave encashment. This was confirmed in the case, Kamal Kumar Kalia v. Union of India [2020] 268 Taxman 398 (Delhi))
When the CPC Bangalore processed Chhaju’s tax return, they restricted his leave encashment tax exemption to Rs 3 lakh and added the balance of Rs 6.53 lakh (Rs 9.53 lakh minus Rs 3 lakh) to his income and asked him to pay tax on it. The Commissioner of Appeals (CIT A) upheld this adjustment. Chhaju then appealed to the ITAT Jaipur.
On August 31, 2026, Chhaju won the case in ITAT Jaipur. He no longer has to pay any income tax on his Rs 9.53 lakh leave encashment.
How much income tax exemption can you claim for leave encashment?
Leave encashment at the time of retirement is a benefit under which employees receive a cash payment for earned privilege leave accumulated during their period of service. The tax treatment of such payment depends on whether the employee is a government or non-government employee.
Chartered Accountant Suresh Surana says that while leave encashment received by Central or State Government employees at the time of retirement is fully exempt, private-sector and other non-government employees can claim exemption only up to the limits prescribed under the income-tax law. For a private-sector employee, the amount of exemption is restricted to the lowest of the following amounts:
- Actual leave encashment received
- Cash equivalent of earned leave standing to the employee’s credit at the time of retirement, with the earned leave entitlement restricted to a maximum of 30 days for each year of actual service
- 10 months’ average salary, based on the average monthly salary for the 10 months immediately preceding retirement
- Rs 25 lakh ceiling limit since 2023. This means the Rs 25 lakh limit is a lifetime cap across all employers. Leave encashed while still in service is fully taxable.
For instance, if a retired employee gets Rs 30 lakh as leave encashment but the income tax exemption calculated under the specified parameters works out to Rs 20 lakh, the actual income tax exemption would be restricted to Rs 20 lakh and the balance Rs 10 lakh would be taxable. Further, the Rs 25 lakh ceiling applies on an aggregate basis.
The examples below assume Rs 25 lakh is the lowest of the four limits.
| A: Rs 30 lakh | B: Rs 20 lakh | |
|---|---|---|
| Leave encashment received | 30,00,000 | 20,00,000 |
| Exempt u/s 10(10AA) | 25,00,000 | 20,00,000 |
| Taxable leave encashment | 5,00,000 | Nil |
| Pension | 12,00,000 | 12,00,000 |
| Less: standard deduction | (75,000) | (75,000) |
| Total taxable income | 16,25,000 | 11,25,000 |
| Tax at slab rates | 1,25,000 | 52,500 |
| Less: Sec 87A rebate | – | (52,500) |
| Add: 4% cess | 5,000 | – |
| Total tax | 1,30,000 | Nil |
Note: Assumes new regime slabs for FY 2025-26/2026-27, no other income or deductions, and no surcharge.
Source: Pranshu G, Partner at Ashok Pranshu & Co
Therefore, where an employee has claimed leave encashment exemption from a previous employer, the amount of exemption already claimed would reduce the ceiling available subsequently.
Surana says that if a retiree wants to claim income tax exemption on leave encashment while filing their ITR then the retiree should report the leave encashment as part of salary income in the Schedule Salary of the applicable ITR and separately disclose the eligible tax exempt portion under the prescribed field for exempt allowances.
Surana says: "Any amount received over and above the eligible exemption is taxable under the head “Salaries” in the year of receipt and is taxed at the normal slab rates applicable to the employee. There is no separate or special tax rate applicable to the excess leave encashment."
What happens to leave encashment beyond Rs 25 lakh?
Pranshu G, Partner at Ashok Pranshu & Co said to ET Wealth Online that any amount above Rs 25 lakh, or above whichever of the four limits is lowest, is fully taxable as salary in the year it is received. It is added to the retiree's other income and taxed at slab rates, and the employer deducts TDS on it. Because years of accumulated leave are taxed in a single year, the excess can push a retiree into the 30% bracket. Under the new regime it can also cost them the Section 87A rebate entirely, as Example A shows in the above table. The Rs 25 lakh is a lifetime limit, so anyone who claimed an exemption from a previous employer gets only the balance.
ITAT Jaipur discussion
Higher leave encashment limit is remedial and can be applied to those employees who retired shortly before its notification
ITAT Jaipur observed that the power under sub-clause (ii) is not untrammelled, for it is to be exercised having regard to the limit applicable to the employees of the Central Government, and its exercise is a continuing obligation. The revision of 2023 was thus not the grant of a fresh exemption but the belated discharge of that obligation, the limit having remained at Rs 3 lakh since 2002 through successive revisions of Central Government pay.
ITAT Jaipur said: “A notification of that character is remedial, and to withhold its benefit from an employee who retired shortly before it was issued would perpetuate the very disparity it was meant to remove.”
ITAT Jaipur said that a Coordinate Bench in Narender Singh Yadev v. ACIT [2023] 152 taxmann.com 187 (Jaipur - Trib.) granted full exemption only after finding, on the strength of a Gazette Notification, that the employer there was a government institution, distinguishing the Kamal Kumar Kalia case on that footing.
ITAT Jaipur said: “The amount of Rs 9,53,763 received by him (Chhaju) is well within the limit of Rs 25,00,000, and no other limit prescribed by the sub-clause has been applied against him.”
Thus, ITAT Jaipur gave Chhaju full tax exemption on his Rs 9.53 lakh leave encashment and cancelled the tax notice.