A retired ONGC employee who claimed tax exemption on Rs 19.05 lakh received as leave encashment at the time of retirement has won relief from the Income Tax Appellate Tribunal (ITAT). The tax department had restricted the exemption to just Rs 3 lakh and taxed the remaining amount, but the tribunal ruled in favour of the taxpayer and allowed exemption on the full amount.
The ruling could be important for many retired employees who received leave encashment and are involved in similar tax disputes.
What was the case about?
The case involved Chennai resident Balasubramanian Venkatachalaperumal, a former employee of Oil and Natural Gas Corporation (ONGC), who retired during the financial year 2019-20.
At the time of retirement, he received Rs 19,05,997 as leave encashment. While filing his income tax return for Assessment Year 2020-21, he claimed exemption on the entire amount under Section 10(10AA) of the Income Tax Act.
However, when the return was processed by the Centralised Processing Centre (CPC), Bengaluru, the exemption was restricted to Rs 3 lakh. The balance Rs 16.05 lakh was added to his taxable income.
The taxpayer challenged the adjustment, but the first appellate authority, Commissioner of Income Tax (Appeals), upheld the tax department’s action.
The matter eventually reached the Chennai bench of the ITAT.
Why did the tax department allow only Rs 3 lakh exemption?
At the time of the taxpayer’s retirement in FY 2019-20, the exemption limit for leave encashment received by non-government employees was capped at Rs 3 lakh.
This limit had remained unchanged since 2002 despite significant increases in salaries over the years.
In May 2023, the Central Board of Direct Taxes (CBDT) increased the exemption limit for non-government employees from Rs 3 lakh to Rs 25 lakh through Notification No. 31/2023.
The dispute before the tribunal was whether this enhanced limit could benefit a taxpayer who had retired before the notification was issued.
What did ITAT say?
The tribunal noted that the increase in the exemption limit from Rs 3 lakh to Rs 25 lakh was not the introduction of a new tax benefit. Rather, it was an update to an existing provision aimed at reflecting current salary levels and removing disparity between government and non-government employees.
The bench observed that the revision came after nearly two decades and was intended to mitigate hardship faced by retirees.
According to the tribunal, beneficial and remedial provisions should be interpreted liberally, especially when they are designed to remove hardship and no vested right of the Revenue is adversely affected.
The ITAT also noted that denying the enhanced exemption would create an unfair distinction between employees who retired before and after the notification despite being similarly placed.
Relying on a series of earlier tribunal rulings on the same issue, the Chennai bench held that the taxpayer was entitled to claim exemption up to the revised limit of Rs 25 lakh.
Since the leave encashment amount of Rs 19.05 lakh was well within that limit, the tribunal directed the tax department to allow exemption on the entire amount.
How is leave encashment taxed?
According to Vishal Gada, Founder and CEO of Aurtus, the tax treatment of leave encashment depends on whether the employee is a government employee or a non-government employee.
“Government employees enjoy complete tax exemption on leave encashment received at retirement. There is no upper limit on the amount that can be claimed as exempt,” he says.
For private sector and PSU employees, however, the exempt amount is determined based on the lowest of four figures:
-Actual leave encashment received
-Statutory exemption limit of Rs 25 lakh
-Ten months’ average salary immediately preceding retirement
-Cash equivalent of unutilised earned leave, subject to a maximum accumulation of 30 days for every completed year of service
Does the mode of separation matter?
Gada says the Income Tax Act uses the phrase “on retirement or otherwise”, which has been interpreted broadly by courts and tribunals over the years.
As a result, leave encashment received on superannuation, voluntary retirement or premature retirement is generally eligible for tax exemption.
However, there is an important distinction.
“If an employee encashes leave while continuing in service with the same employer, the amount is fully taxable as salary and no exemption is available,” he explains.
Why do taxpayers receive notices in leave encashment cases?
Tax disputes involving leave encashment are often triggered by reporting errors, mismatches or differing interpretations of exemption limits.
According to Gada, one common reason is the retirement date itself.
“The enhanced Rs 25 lakh limit officially applies to retirements or separations occurring on or after April 1, 2023. When taxpayers claim the higher exemption for earlier years, CPC systems may automatically restrict the claim to the old Rs 3 lakh limit, resulting in a tax demand or adjustment,” he says.
Another common issue arises when the exempt portion is not correctly reported in Form 16 but is claimed separately in the income tax return.
Such mismatches often attract automated scrutiny.
Taxpayers also make mistakes while calculating leave accumulation. While some employers allow accumulation of more than 30 days of leave per year, income tax rules permit only 30 days per completed year of service for exemption calculations.
In addition, the Rs 25 lakh exemption is a lifetime cumulative limit. Any exemption claimed with a previous employer reduces the available limit for future claims.
How can taxpayers avoid such disputes?
Experts advise taxpayers to carefully verify leave encashment calculations before filing returns.
Gada recommends ensuring that the exemption calculation complies with the 30-day accumulation rule, that the exempt amount is correctly disclosed under the relevant section in the return, and that retirement dates support the exemption being claimed.
“If a genuine claim is denied due to a CPC processing error, taxpayers should consider filing a rectification request or pursuing an appeal while relying on relevant provisions of the Income Tax Act and judicial precedents,” he says.
The latest ITAT ruling adds to a growing list of tribunal decisions that have granted relief to retired non-government employees in leave encashment disputes and may provide support to taxpayers involved in similar cases.
Disclaimer: This article is for informational purposes only and is based on the ITAT ruling in the specific facts of the case discussed. Tax implications may vary depending on an individual’s employment history, retirement date, leave accumulation, salary structure and other factors. The ruling may be subject to further appeal. Readers should consult a qualified tax professional before making any tax-related decisions or claims based on this information.
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