Retrospective Enhanced Limit of Leave Encashment: Will Rs 25 lakh exemption cover FY 2022-23?

In a significant move aimed at providing relief to non-government employees, the Central Board of Direct Taxes (CBDT) has recently notified an increase in the tax exemption limit for leave encashment from Rs 3 lakh to Rs 25 lakh. The historical increase in the exemption threshold comes after a period of 21 years and is in accordance with the Budget Speech of the Hon’ble Finance Minister. This decision comes as a welcome relief for employees, allowing them to enjoy increased tax benefits and greater financial flexibility.

Let us delve into the details of the notification and the possibility of applying it retrospectively for employees retiring in FY 2022-23.

Historical Background

Leave encashment refers to the practice of converting accumulated leaves into cash, usually granted to employees upon retirement, resignation or termination of employment. Since the amount received is received as per the contract of employment, generally the said sum would be taxable under the head “income from salary” as per Income-tax Act, 1961 (Act). 

However, the legislature has provided certain exemptions under section 10(10AA) of the Act in relation to sums of leave encashment received at the time of retirement of employees. While in the case of Central/State Government employees, the entire leave encashment is exempt from tax, in the case of other employees, the exemption is subject to limits prescribed by the Central Government.  

Also Read: New tax benefit for non-government salaried employees: CBDT notifies Rs 25 lakh Leave Encashment limit

The Central Government periodically revises the tax exemption limit for leave encashment to provide relief to non-government employees by way of notifications. In the past, such notifications provided that the revised threshold for leave encashment will apply in respect of retirement taking place during a specified period/on or after a specified date. For example, a notification issued in 1996 increased the threshold for leave encashment from Rs 79,920 to Rs 1,30,320 in respect of employees retiring between 01^st April 1995 to 30^th June 1995. The erstwhile limit of Rs 3,00,000 was notified in 2002 and was retrospectively applicable to employees retiring from 01^st April 1998. 

Recent notification- the moot question

It is worth noting that the latest notification increases the threshold of exemption from Rs 3 lakh to Rs 25 lakh. However, unlike previous notifications, the latest notification does not expressly specify the period during which the employees should retire for application of the increase of exemption threshold. Rather, it merely states that the notification shall be deemed to have come into force with effect from 01.04.2023. A crucial question may therefore arise as to whether a person who retires during the Financial Year (FY) 2022-23 can avail of the benefit of the substantially enhanced limit of Rs 25 lakh or the increased limit is applicable only to a person who retires after 01.04.2023? 

Applying Rs 25 lakhs limit for FY 2022-23 – the possibility

It is well settled in income tax law that the law as it stands on the first day of the assessment year is applicable unless and until any amendment made in the Act, notification issued therein is specifically made applicable from an anterior date. The Apex court in the case of Reliance Jute & Industries Ltd. v. Commissioner of Income-tax reiterated that it is a cardinal principle of the tax law that the law to be applied is that in force in the assessment year unless otherwise provided expressly or by necessary implications. 

Applying the above well-settled principles, it can be said that the recent notification enhancing exemption should be read as applicable from AY 2023-24, as the said notification is effective on the first day of the said AY. 

Further, it is a well-established principle that a statute which affects substantive rights is presumed to be prospective in operation unless made retrospective, either expressly or by necessary intendment. It is pertinent to mention the recent notification expressly mentions that the said notification is intended to have a retrospective operation with effect from 01st April 2023. Thus, by stating so, the Central Government has itself approved the retrospective application of the said notification. 

Also Read: ITR filing AY 2023-24: How much deduction is allowed for stamp duty, property registration fee?

Also, based on the trend observed in all the previously released notifications for leave encashment exemption, the Central Government has been providing the benefit of enhanced exemption for the years preceding the date of notification (by identifying the retiring date prior to the date of issuance of notification). Therefore, the application of notification from the AY 2023-24 appears to be in line with the practice previously followed while notifying the amended limits. 

Needless to mention, the Income Tax Return (ITR) forms notified for AY 2023-24 presently allow the limit of Rs 3 lakh for leave encashment exemption. This could be possibly because the return forms were last updated on 05.05.2023 and the recent notification was rolled out on 24.05.2023. It is possible that if the notification is in fact intended to be applied with effect from AY 2023-24, the return filing utility may further be updated to enable taxpayers to claim the enhanced limit of Rs 25 lakh for AY 2023-24. In such a case, the taxpayers will be able to claim refund of excess tax deducted by their employer by applying the limit of Rs 3 lakh.

However, it is worth mentioning here that the alternate possibility that the increase in threshold is intended to be applied to employees retiring from 01^st April 2023 cannot be ruled out. The increase in threshold is a result of the commitment made by the Hon’ble Finance Minister vide her Budget Speech in February’23. The speech did not in any way indicate that the threshold was intended to be increased retrospectively.

Further, the Finance Act, 2023 made various amendments to certain exemptions provisions contained in section 10 of the Act. However, all such amendments have been made with effect from 01^st April 2024 and are applicable prospectively from AY 2024-25. Thus, from a policy standpoint the increase in exemption threshold in section 10(10AA) from AY 2023-24 does seem to be unconventional as compared to other amendments made to exemption provisions vide Finance Act, 2023. 

Conclusion

Though the ITR forms cannot go contrary to what the law on true interpretation envisages, still a clarification from the Central Government regarding the applicability of significant enhancement of limit to retiring employees in FY 2022-23 would bring certainty for taxpayers who are availing the benefit of leave encashment exemption for the said year in their ITR. In case no such clarification is issued, it is possible for employees to examine the possibility of filing a claim of excess tax deducted by their employer by applying the erstwhile exemption threshold.

This article has been authored by S.Vasudevan , Executive Partner, Karanjot Singh Khurana, Joint Partner and Prachi Goel, Principal Associate at Lakshmikumaran & Sridharan Attorneys. Views expressed are personal