Jigar M. Patel
International Tax Attorney
Exemption for payments out of Provident Fund
Sections 10(11) and 10(12) of the Income-tax Act grant total tax exemption, without any monetary ceiling, in respect of any payment made to an employee representing the credit balance of his account with any statutory or recognized Provident Fund (PF). This would also include interest accumulated on such credit balance. However, it needs to be borne in mind that if an employee withdraws his PF balance before completion of 5 years of service, he would be required to pay tax on the withdrawn amount.
Cap for Interest Exemption in prescribed cases
However, as per the amendment effective from 1st April, 2021, no exemption shall be available for the interest income accrued in such provident fund, to the extent it relates to the annual contribution made by the employees over the prescribed amount of Rs. 2,50,000 or Rs. 5,00,000 (where no contribution is made by the employer). The CBDT has prescribed the mode for computing the taxable interest in such cases under the notified Income-tax Rule 9D for the purpose.
Taxability of Interest on PF post-retirement
It is quite tempting for employees to continue maintaining their accumulated PF balance even post-retirement on the presumption that the same would continue to enjoy exemption under Sections 10(11) or 10(12). It would be necessary to put in a word of caution for such cases. Income-tax Appellate Tribunals have held that such exemption for interest would be limited to the accumulated balance due and payable to an employee up to the date or retirement or termination of his employment and interest on PF earned post-retirement would not be entitled to exemption.
Exemption in respect of Superannuation Fund Payments
Under Section 10(13), any payment out of an Approved Superannuation Fund is treated as exempt if paid either at the time of death of the employee or upon his retirement after reaching a specified age or on the employee becoming incapacitated prior to such retirement.
Exemption for Leave Encashment
Leave encashment refers to converting unused or accumulated leave days entitlement of a salaried employee into cash or a monetary benefit. Any amount received by way of leave encashment by an employee during the term of his employment is taxable.
However, leave encashment received by an employee at the time of his retirement from service, whether by way of superannuation or otherwise, is exempt under Section 10(10AA) on the following basis:
- In the case of Central or State Government employees, any amount received as leave encashment is fully exempt as tax.
- For non-Government employees (including employees of local authority or statutory corporation) leave encashment is exempt from tax to the extent of the least of the following:
- Cash equivalent of the leave salary in respect of the period of earned leave standing to the credit of the employee at the time of retirement/superannuation.
- 10 months average salary.
- Leave encashment amount actually received.
- Amount specified by the Government. The earlier exemption limit for aggregate amount of leave encashment of Rs. 3 lakhs has been raised to Rs. 25 lakhs with effect from 1st April, 2023.
It has been held by various High Courts that the term “retirement from service” would include not only retirement from superannuation but also voluntary retirement by way of resignation from service. However, where an employee has once enjoyed exemption, at the time the subsequent exemption, the amount of earlier exemption would be suitably reduced from the aggregate limit prescribed for exemption.
