You can claim leave salary even on resignation, not just retirement

Recently, one of my friends, after being with the same company for over 15 years left his job. He had not retired neither had he accepted any VRS. He simply resigned as he had been offered a better position in another firm. As he had been serving for a long time, his termination benefits were quite substantial. One of the components of such proceeds was the leave salary standing to his credit. The problem arose when the company wanted to deduct tax on the full amount of leave salary despite there being a specific section in the Income Tax Act which provides exemption up to specified limits. I understand that this is the general practice as the exemption is available only for those employees who are retiring and not for those who resign. This article examines the veracity of this policy. But first a little background. What is leave salary? If leave standing to the employee's credit is not taken within a year, as per the service rules, it may lapse or it may be encashed or it may be accumulated. The employee can avail the accumulated leave during his service tenure or it can be encashed at the time of retirement or leaving the job. Encashment of leave by surrendering leave standing to one's credit is known as leave salary. Now, if any leave is encashed during the continuity of employment, it is chargeable to tax, irrespective of the fact whether the employee is in government or private service. On the other hand, in the case of any leave encashment at the time of termination of service, the tax treatment differs. For a government employee the entire amount of leave salary is tax free, but for a private sector employee leave salary is only partly exempted (U/S 10 (10AA) up to the least of the following: a. Cash equivalent of the leave salary in respect of the period of earned leave standing to the credit of employee at the time to retirement/superannuation (earned leave entitlements cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired); b. 10 months' 'average salary'; c. ¤3 lakh (applicable from 01.04.1998); d. The amount of leave encashment actually received at the time of retirement. The argument Section 10 (10AA) clearly uses the words, "on retirement or otherwise". The key seems to be the word "otherwise" which clearly seems to suggest that the exemption under the section is available in the case of a person leaving his job for reasons other than retirement. This treatment is also further substantiated by a judgement 142 CTR 325 CIT vs D P Malhotra dated July 28, 1997. The circumstances of this case were exactly similar to those which my friend found himself in; the assessee had resigned from his job and had claimed exemption U/S 10 (10AA) for the amount of leave salary. The claim of the assessee was rejected by the income tax officer as he was of the opinion that the benefit of Section 10 (10AA) is available only in cases where the amount is received by the assessee at the time of retirement which, according to him, did not include resignation. The commissioner of income tax (CIT) ruled in the taxpayer's favour. The CIT held that 'retirement' is a word of wide importance. In the context of employment, it means conclusion of a career. However, one of the meanings of the word 'retire' is 'resign'. This is also validated by a legal Thesaurus, where 'resign' is one of the meanings of 'retirement'. Thus both 'retirement' and 'resignation' mean the conclusion of the service career from that particular employer i.e. resignation from service is also one of the modes of retirement from service. Once an employee resigns, his service stands terminated from the date on which his letter of resignation is accepted by the appropriate authority, unless there is any law or statutory rule governing the conditions of service to the contrary. In other words, on acceptance of resignation, the employee stands retired from service. The word 'retirement' has not been used in the law in the restricted sense to mean 'retirement on superannuation'. On the other hand, it is clear from the language of Section (10AA) itself that it has been used in the widest possible terms to mean and include all cases of retirement, whether on superannuation or otherwise. What is relevant is 'retirement'— how it took place is immaterial for the purpose of this clause. Therefore, it is clear that if on retirement, even on resignation by the employee, he/she gets by way of leave encashment any amount, Section 10 (10AA) would apply and the assessee will be entitled to the benefit of the said clause to the extent mentioned therein. The same view is supported by the decision of the Madras High Court in the case CIT vs R J Shahney (1986) 54 CTR (Mad) 360. In that case also the assessee had resigned and retired from employment. The high court had held: "The retirement may be of various kinds. It may be on superannuation or voluntary. If there is any voluntary retirement from service, we are satisfied that the provisions of S 10 (10AA) would apply."