Aggregate Leave Encashment even on switching jobs is exempt from tax upto Rs 3 lakhs

 

Leave encashment tax relief is not restricted to one job in a year. Every organisation divides the leaves that can be taken by an employee in casual leave (CL), sick leave (SL) and paid leave (PL) and credits them to their account annually. While the CLs and SLs lapse after the year ends, PLs are accumulated in the account and when the employee leaves the organisation, these leaves are encashed and a payment is made to the employee in lieu of them. As per section 10(10AA) of the Income Tax Act, the amount is totally tax free for the government employee, but for the employee working in the private sector, least of the following is exempt from tax:

• Cash equivalent of the leave salary in respect of the period of earned leave to the credit of employee at the time to retirement/superannuation (earned leave entitlements cannot exceed 30 days for every year of actual service), or
• 10 months’ ‘average salary’, or
• Rs 3 lakh (applicable from 1.4.98)
• The amount of leave encashment actually received at the time of retirement.

The section reiterates the words “on retirement, superannuation or otherwise”. Many employers go by the literal meaning and tax the entire amount payable to the employee on resignation. However, there are various case laws to support the view that the leave encashed at the time of resignation fall in the per view of Section 10(10AA) and the exemption is to be calculated as per the rules laid down by the Income Tax Act. The various case laws to support this view are:

• ITAT 15 SOT 229 (DELHI) (04-05-2007) Col.(Retd) Chandra Kumar Shukla Vs ACIT, Circle Noida
• SC-HC/AAR 142 CTR 325 (BOM) (28-05-1997) CIT vs D P Malhotra
• ITAT 36 ITD 315 (MAD) (06-11-1990) R K Ambady Vs ITO
• ITAT 32 ITD 514 (BOM) (22-11-1989) S P Banerjee Vs DCIT
• ITAT 32 ITD 117 (AHD) (31-05-1989) ITO Vs Manubhai K Mehta
• ITAT 59 ITR 160 (MAD) (10-12-1984) CIT Vs R J Shahney

The courts in the various above mentioned judgements have upheld that voluntary retirement or change of job is covered by section 10(10AA). In the case of ITAT decision in Col.(Retd) Chandra Kumar Shukla Vs ACIT, Circle Noida 15 SOT 229 (DELHI) (04-05-2007) , the facts of the case was

• The assessee is an individual. He filed his return of income for the assessment year 2004-05 declaring a total income of Rs. 5,62,280. The assessee has claimed exemption of a sum of Rs. 2,15,449 under section 10(10AA)(ii) of the Act. The assessee had taken up premature retirement in the army on 14-6-1994. On retirement from the army, he had received a sum of Rs. 81,378 being the leave encashment of 215 days in the assessment year 1995-96 the assessee had claimed Rs. 81,370 as exemption under section 10(10AA)(i) of the Act.
• After his retirement from the army the assessee worked with M/s. Microwave Communications Ltd. and resigned from this company in January, 2004. At the time of his resignation from Microwave Communications Ltd, he received a total sum of Rs. 6,89,448. Out of this he claimed that a sum of Rs. 2,15,449 as exempt under section 10(10AA)(ii) of the Act. The sum received during the P.Y. represents leave encashment in respect of 180 days.
• The Assessing Officer was of the view that under the provisions of section 10(10AA) of the Act the period of leave encashment cannot exceed more than 300 days as laid down in the Second Proviso to section 10(10AA)(ii) of the Act. Since the assessee had already availed an exemption in respect of leave encashment of 215 days in his service with the army the Assessing Officer was of the view that the total period of leave encashment would be 395 days (180 days + 215 days). The Assessing Officer therefore proposed to restrict the claim for exemption under section 10(10AA)(ii) for leave encashment in respect of 85 days and disallow the claim for exemption in respect of leave encashment for 95 days.

The Claim of Assessee

The assessee submitted that while allowing exemption claimed under section 10(10AA)(ii) of the Act the number of days for which leave encashment had been obtained while in army service should not be added and that the period of 300 days has to be computed with reference to the private employment with Microwave Communications Ltd. under section 10(10AA)(ii) of the Act. It is only for considering the monetary limit of Rs. 3 lakhs as mentioned in Second Proviso to section 10(10AA)(ii) of the Act that the amount received as leave encashment from employment in the army has to be considered and not the period spent in the employment of army i.e., with the Government. The Assessing Officer however refused to accept the plea of the assessee. For the following reasons the Assessing Officer disallowed the claim for exemption to the extent of Rs. 1,13,707.

The Tribunal Held as under

5. A plain reading of the above provisions clearly shows that in the case of exemption the payment received from the Central Government in respect of period of Earned Leave is totally exempt under section 10(10AA)(i) of the Act, subject to the monetary limit laid down in the Second Proviso to section 10(10AA)(ii), which is Rs. 3 lakhs. As far as the exemption under section 10(10AA)(ii) is concerned, the time-limit of 10 months of leave encashment is the overall ceiling limit for which exemption is allowed. This period of 10 months has to be construed with reference to the employment of the assessee other than as an employee of the Central Government or a State Government. The period of leave encashment as a Government servant should not be added under section 10(10AA)(ii). A combined reading of sub-clauses (i) and (ii) of section (10AA) clearly shows that a maximum period of 20 months of leave i.e., 10 months as a Government employee and 10 months as a private employee may be encashed for the purpose of exemption from income-tax at the time of retirement or resignation subject to the ceiling monetary limit of Rs. 3,00,000 in accordance with the proviso to section 10(10AA)(ii). Sub-clauses (i) and (ii) of section 10(10AA) are independent provisions and, therefore, it does not mean that once a Government employee avails his full period of leave encashment i.e., ten months under sub-clause (i) he is debarred from encashing any period of leave salary under sub-clause (ii). The above interpretation would put the Government employee to a disadvantage when he takes up a job in the private sector and such a consequence could not have been the intention of the Legislature. The two provisos appear under sub-clause (ii) only and, therefore, these provisos control only that sub-clause as is evident from the words “in this sub-clause” occurring in the said two provisos. Hence any period of leave encashment availed of by a Government employee should not be counted towards the period of leave encashment availed of by him as a private employee. The object of the two provisos inserted under sub-clause (ii) of section 10(10AA) is to ensure that a private employee does not avail leave encashment of more than Rs. 3,00,000 by adopting the device of resignation from service under one employer and then joining another employer for the purpose of leave encashment. The expression “at the time of his retirement” occurring in sub-clause (ii) of section 10(10AA) refer to the period of earned leave at the credit of the private employee and not at the credit of a Government employee which he might have encashed at the time of his retirement. Therefore, a private employee is entitled to encash up to ten months of his leave salary for the purpose of exemption from income-tax subject to a ceiling monetary limit of Rs. 3,00,000 notwithstanding the fact that such an employee might have encashed any period of his leave salary for the purpose of exemption from income-tax as a Government employee under section 10(10AA)(i).

6. The ld. counsel had placed reliance on the following decisions.

(a) R.K. Ambady v. ITO [1991] 36 ITD 315 (Mad.).

Wherein the Chennai Bench of the ITAT had explained the scheme of allowing exemption under section 10(10AA). Prior to introduction of section 10(10AA) even leave encashment on retirement from Government service was taxable. While introducing the exemption the Legislature categorized Government and Non-Government employees and in respect of the conditions to be present in a scheme of leave encashment had thought it fit to apply the parameters that were prevailing in the Government schemes as a condition even in respect of leave encashment scheme of employees other than Central and State Government. This also shows that both sub-clauses (i) and (ii) of section 10(10AA) are mutually exclusive.

(b) In the case of CIT v. N.J. Pavri [1999] 237 ITR 4721 the Hon’ble Bombay High Court has also taken the view in the context of identical provisions of exemption in the case of death-cum-retirement gratuity that the Second Proviso was relevant only for calculating the overall monetary ceiling limit.

(c) Further reliance was placed on the decision of the Hon’ble Supreme Court in the case of Mahim Patram (P.) Ltd. v. UOI 2007 (3) Scale 584 wherein the Hon’ble Supreme Court had emphasized the need for a strict construction of tax statutes and the necessity of not subjecting a person to tax without there being conditions existing for such liability within the letter of the law.

We find that all the aforesaid decisions support the plea of the assessee and the interpretation of the provisions of section 10(10AA) as sought to be made by the assessee which we have already extracted above and with which we agree. We therefore hold that the assessee’s claim for exemption under section 10(10AA) as made has to be allowed. The appeal of the assessee is allowed.