Leave Encashment Tax Exemption: The ₹25 Lakh Lifetime Cap, Explained
Leave encashment received by a non-government employee, on retirement or otherwise, is exempt under Section 10(10AA) — but only up to the least of four separately computed figures. Getting any one of the four wrong changes the exemption; missing that the fourth is a lifetime figure, not a per-event one, is the mistake that costs the most.
The Four Legs
The exemption is the least of:
- Actual leave encashment received
- 10 months' average salary (last drawn, in most computations)
- Cash equivalent of leave standing to credit, capped at 30 days for each completed year of service
- ₹25,00,000
Whichever of the four produces the smallest figure sets the exemption ceiling — actual encashment above that figure is taxable as salary income.
Why the ₹25 Lakh Cap Is the One People Get Wrong
The ₹25,00,000 figure (revised by CBDT Notification 31/2023, effective 1 April 2023, and unchanged since) is a lifetime cap across every employer a person has worked for, not a per-employer or per-encashment allowance. Someone who claimed ₹10,00,000 of exemption on leave encashment from a previous employer has only ₹15,00,000 of headroom left under this leg when a later employer's encashment is being tested — the full ₹25 lakh isn't available fresh at each new job or each new encashment event.
Practically, this means the fourth leg of the test isn't just "is total encashment under ₹25 lakh" — it's "is total encashment, added to whatever exemption has already been claimed against this same lifetime cap at any prior employer, under ₹25 lakh."
The 30-Days-Per-Year Ceiling on Leg 3
Leg 3 isn't simply "whatever leave is standing to credit" — it's the cash equivalent of leave to credit, but capped at 30 days for each completed year of service. An employee whose HR policy allows leave to accumulate beyond 30 days per year of service still only gets 30 days per completed year counted toward this leg of the exemption test, regardless of how much leave the employer's own policy lets them bank.
Same Structure, Same Method as Gratuity — For the Accounting Side
For accounting purposes (Ind AS 19 / AS 15), the leave-encashment liability is computed using the same Projected Unit Credit method used for gratuity — projecting future salary growth and leave accrual to retirement, then discounting back the portion attributable to service already rendered, adjusted for the probability of survival in employment (attrition) to that future date. It's structurally the same actuarial mechanics as a gratuity DBO computation, just applied to leave days instead of a fixed gratuity formula.
Frequently Asked Questions
Is the ₹25 lakh exemption available fresh at each employer?
No. It's a lifetime cap across all employers. Exemption already claimed at a previous employer reduces the headroom available under this leg when a later employer's leave encashment is tested — the two don't reset independently.
Which figure sets the actual exemption — the highest or lowest of the four legs?
The lowest. The exemption is the least of the four computed figures; whichever produces the smallest number caps the exemption, and any actual encashment above that figure is taxable.
Does the 30-days-per-year cap apply even if the employer's leave policy allows more accumulation?
Yes. Leg 3 of the exemption test caps at 30 days per completed year of service regardless of how generous the employer's own accumulation policy is — the tax exemption test applies its own ceiling independent of HR policy.
Is the Ind AS 19 leave-encashment liability computed differently from gratuity?
No — it uses the same Projected Unit Credit method: project future salary and leave accrual to retirement, attribute the portion earned to date, adjust for attrition probability, and discount back to present value. The formula inputs differ (leave days vs a fixed gratuity multiple) but the actuarial mechanics are the same.
CORAA's Leave Encashment Calculator runs all four legs of the Section 10(10AA) test — including tracking the lifetime cap net of prior-employer claims — alongside the Ind AS 19 / AS 15 Projected Unit Credit computation for the accounting-side liability, off the same inputs.