Should I consult a Chartered Accountant for leave encashment tax planning?

Yes. Leave encashment often involves high-value retirement payouts and potential litigation exposure. Consulting a Chartered Accountant helps ensure maximum lawful exemption, correct reporting, and compliance.

The ₹25 Lakh Leave Encashment Leap: More Than Just a Budget Update

Q: Is the ₹25 Lakh leave encashment exemption available under the new tax regime?

Yes. The ₹25 Lakh leave encashment exemption is available under both the old and the new tax regimes.

Q: Are PSU and bank employees treated as government employees for leave encashment?

No. Employees of Public Sector Undertakings and nationalised banks are treated as non-government employees under Section 10(10AA). Their leave encashment exemption is capped at ₹25 Lakh.

Q: Can retirees who retired before April 1, 2023 claim the ₹25 Lakh exemption?

For retirements before 1 April 2023, the statutory exemption limit was ₹3 Lakh. However, recent ITAT rulings have in some cases allowed relief for pending or disputed assessments, subject to facts and legal merits.

Q: Is leave encashment fully taxable for private sector employees?

No. Leave encashment is partially exempt for private sector employees, subject to the ₹25 Lakh cap and conditions prescribed under Section 10(10AA) of the Income-tax Act.

Author: CA Shiwali Dagar
Published: January 2026

Introduction

For over two decades, the exemption limit for leave encashment under Section 10(10AA)(ii) remained frozen at ₹3,00,000. While salaries of government employees increased substantially through successive Pay Commissions, the corresponding exemption for non-government employees failed to keep pace.

The enhancement of this limit to ₹25 Lakh is not merely a budgetary announcement—it is a long-overdue correction of an administrative and tax-policy anomaly.

Understanding the Frozen ₹3 Lakh Limit

When the ₹3 lakh exemption was notified in 2002, it was logically linked to the salary structure of the highest-ranking government official at the time.

The Original Benchmark

Reference Salary: Cabinet Secretary (₹30,000 per month)
Formula Applied: 10 months of average salary
Result: ₹30,000 × 10 = ₹3,00,000

At that point, the exemption reflected parity between government and non-government employees.

What Went Wrong Over 20 Years

Over the years:

Cabinet Secretary salaries increased to ₹2.5 lakh per month
Multiple Pay Commissions revised government compensation
But the leave encashment exemption for non-government employees remained unchanged

This created a 21-year tax imbalance, penalising senior private-sector professionals and PSU retirees.

Judicial Conflict: Divergent Legal Views

Before the 2023 notification, taxpayers challenged the outdated limit in various courts, resulting in conflicting judicial interpretations.

1️⃣ The Strict View (Patna & Delhi High Courts)

In cases such as Kamal Kumar Kalia vs Union of India, courts held:

Exemption is a statutory concession, not a legal right
Courts cannot substitute legislative intent
Without a fresh notification, the ₹3 lakh limit must apply

This view prioritised literal interpretation over equity.

2️⃣ The Equitable View (Recent ITAT Rulings)

Post-2023, a more purposive interpretation has emerged, particularly from ITAT benches (e.g., Pune ITAT – 2025):

The ₹25 lakh limit is beneficial and clarificatory
It reflects the original intent of aligning with government pay scales
In some cases, relief has been granted for pending or disputed assessments of earlier years

This shift opens the door for remedial action for select taxpayers.

The Law as It Stands Today (2026)

✔ ₹25 Lakh exemption applies to retirements on or after 1 April 2023
✔ Available under both Old and New Tax Regimes
✔ One of the rare exemptions surviving the new regime structure

Critical Compliance Checks for Taxpayers

🔹 PSU & Bank Employees

Employees of:

Public Sector Undertakings
Nationalised Banks

are treated as non-government employees under Section 10(10AA).

➡️ Their exemption is capped at ₹25 Lakh, not fully exempt.

🔹 Retirements Between 2002–2023

This period remains a litigation-sensitive zone.

If you or your clients:

Retired between 2020 and 2023
Paid tax on leave encashment exceeding ₹3 lakh

➡️ It may be possible to explore:

Rectification applications
Appeals based on recent ITAT precedents

Each case requires careful factual and legal evaluation.

Professional Insight by CA Shiwali Dagar

The ₹25 Lakh enhancement was not a fiscal giveaway—it was the rectification of a long-standing administrative oversight. However, mixed judicial views remind us of a critical truth in tax law:

In taxation, a notification often carries more weight than the logic of the Act itself.

Strategic planning, timely action, and informed litigation advice are essential—especially for high-value retirement benefits.

Need Expert Guidance?

If you are:

A retiring employee
A PSU or bank employee
Facing scrutiny or disputes on leave encashment
Exploring retrospective tax relief

Consult CA Shiwali Dagar for personalised tax planning and litigation support.

📍 South Delhi
📞 9266032777

Frequently Asked Questions (FAQs)

1. What is the maximum exemption available on leave encashment in 2026?

The maximum exemption available under Section 10(10AA)(ii) for non-government employees is ₹25 Lakh for leave encashment received at the time of retirement or superannuation, applicable for retirements on or after 1 April 2023.

2. Is the ₹25 Lakh leave encashment exemption available under the new tax regime?

Yes. The ₹25 Lakh exemption for leave encashment is available under both the old and the new tax regimes, making it one of the few exemptions that continue to apply under the new regime.

3. Are PSU and bank employees treated as government employees for leave encashment?

No. Employees of Public Sector Undertakings (PSUs) and nationalised banks are treated as non-government employees for the purpose of Section 10(10AA). Their exemption is therefore capped at ₹25 Lakh, not fully exempt.

4. Can retirees who retired before April 1, 2023 claim the ₹25 Lakh exemption?

For retirements before 1 April 2023, the law prescribed a ₹3 Lakh limit. However, recent ITAT rulings have, in certain cases, treated the ₹25 Lakh limit as beneficial or clarificatory for pending assessments. Each case requires careful legal evaluation.

5. Is leave encashment fully taxable for private sector employees?

No. Leave encashment is partially exempt for private sector employees, subject to the ₹25 Lakh cap and other conditions under Section 10(10AA).

6. Do I need professional advice for leave encashment tax planning?

Yes. Leave encashment involves high-value payouts and potential litigation exposure, especially for senior executives and retirees. Professional advice helps ensure maximum lawful exemption and compliance.