Exit Payout Under I-T Lens? ITAT Ruling Backs Full Exemption on Leave Encashment

Employees receive leave encashment in exchange for unused leave when they retire or exit a company. Typically, this money acts as a financial cushion for employees after leaving a job.

However,  lack of awareness regarding its tax treatment can lead to individuals ending up surrendering a part of their hard-earned payout to taxes. A recent judgment by the Income Tax Appellate Tribunal (ITAT) shows that taxpayers can claim and protect this money, provided they know the tax laws governing their leave encashment.

What Happened In The Case

Renu Moongia, a retiree, received a leave encashment payout of Rs 9,04,669 upon retiring from the Life Insurance Corporation of India on June 30, 2020. Following her retirement, she filed her income tax return claiming a full deduction on the entire amount.

However, the Income Tax Department restricted her allowable deduction to just Rs 3,00,000. The tax authorities argued that under Section 10(10AA) of the Income Tax Act, 1961, the maximum allowable exemption for her category was only Rs 3,00,000, and they sent an intimation disallowing the remaining Rs 6,04,669 out of her leave encashment.

The taxpayer appealed this disallowance before the Commissioner of Income Tax Appeals (CITA), who maintained that the tax department's move was correct and dismissed her appeal. Additionally, the tax consultant she hired to handle the appeal also failed to file the subsequent challenge or inform her of the dismissal. Moongia only discovered the problem when she received a high tax demand. This led to a delay of 1277 days in filing her appeal before she ultimately filed an appeal before the Jaipur Bench of the ITAT.

The tribunal evaluated the reasons for the delay and decided to condone it. The bench highlighted that a retired individual should not be penalised for the failures of a hired professional.

"It is a settled principle of law that mistake or negligence on the part of a tax consultant engaged by the assessee cannot be attributed to the assessee, and he/she should not be made to suffer," Judicial Member Kuldip Singh said in the order.

The tribunal  also ruled in favour of the taxpayer. The ITAT noted that the Central Board of Direct Taxes (CBDT) issued a notification on May 24, 2023, which officially revised the exemption limit under Section 10(10AA) to Rs 25,00,000.

Relying on past rulings, the ITAT declared that circulars should be applied liberally to provide relief. The tribunal finalised the decision by acknowledging her long service and declaring the entire payout tax-exempt.

"So in view of what has been discussed above, we are of the considered view that the assessee, who has received an amount of Rs. 9,04,669/- on account of leave encashment as retiral benefits after putting in more than 30 years in Life Insurance Corporation of India, is exempted u/s 10(10AA) of the Act," the ITAT said.

What The ITAT Ruling Means For Employees

The ruling provides a critical roadmap for retiring or exiting employees regarding the taxation of their unutilised leaves. Taxpayers must be aware that the exemption ceiling for leave encashment under Section 10(10AA) is no longer capped at the Rs 3 lakh mark, but has been expanded to Rs 25 lakh.

Thus, employees should actively ensure that their employers and the tax processing centres apply this updated limit when assessing their exit payouts. Additionally, employees must monitor their tax portals for intimations and demands to prevent massive delays in the appeals process. By understanding both the increased limit and the necessity of direct involvement in their filings, employees can ensure their hard-earned encashment remains tax-exempt.