Published 9 May 2026
Central Board of Direct Taxes Notification No. 31 of 2023 dated 24 May 2023 -- the eight-fold expansion of the non-government leave encashment ceiling under sub-clause (10AA) of section 10 of the Income-tax Act, 1961; the historical context of the parity argument; the implications for senior executives planning retirement; the interaction with section 89 spread mechanics; and the only major exemption-expansion in a budget cycle dominated by exemption-restrictions
Taxpayer Brief
Amid the cluster of provisions tightening tax-free benefits for high-net-worth individuals -- the Provident Fund Rs 2.5 lakh cap, the ULIP Rs 2.5 lakh cap, the traditional life-insurance Rs 5 lakh cap, the curtailment of Section 80EEA window, the addition of Section 194T partner withholding -- the Central Board of Direct Taxes Notification No. 31 of 2023 dated 24 May 2023 stands out as the rare REVERSE move. The non-government leave encashment ceiling under sub-clause (10AA) of section 10 of the Income-tax Act, 1961 was raised from rupees three lakh (the level since 2002) to rupees twenty-five lakh -- an eight-fold expansion. This article situates the expansion in its historical context, explains why it was needed (the original Rs 3 lakh ceiling having become near-meaningless for senior executives), and walks through the interaction with the section 89 spread mechanism (RET-06) for the part of the leave-encashment that still falls outside the new ceiling. While substantively covered in RET-02, this HNI-series treatment focuses on the strategic implications and the parity argument that drove the legislative shift.
Complexity Matrix
Feature | Complexity Level | Primary Risk |
|---|---|---|
Standard senior executive retirement with leave encashment up to Rs 25L | Low | Within new ceiling; full exemption |
Senior executive with leave encashment Rs 25-40L | Medium | Excess subject to section 89 spread relief |
Multi-employer career with cumulative encashment receipts above Rs 25L | High | Lifetime aggregate cap |
Retirement during 2022-23 (pre-notification) -- subject to old Rs 3L cap | Very High | No retroactive benefit; transitional case |
1. The Historical Context -- The Parity Argument
Year | Leave Encashment Ceiling (Non-Government) | Context |
|---|---|---|
1998 (when sub-clause 10AA was inserted) | Rs 1.35 lakh | Initial calibration |
2002 (last revision before 2023) | Rs 3 lakh | Notification; modest update |
2002-2023 (21-year freeze) | Rs 3 lakh (unchanged) | Inflation steadily eroded the real value |
2018 (gratuity ceiling raised) | (Comparable comparison) Gratuity ceiling raised from Rs 10L to Rs 20L | Parity argument starts emerging -- why gratuity moves but leave encashment does not |
2024 (gratuity further raised) | (Comparable) Gratuity ceiling raised from Rs 20L to Rs 25L by Finance Act, 2024 | Renewed parity argument |
May 2023 -- CBDT Notification 31/2023 | Rs 25 lakh (raised from Rs 3 lakh) | EIGHT-FOLD INCREASE; parity restored with gratuity ceiling |
The 21-year freeze and the parity restoration From 2002 to 2023, the non-government leave encashment ceiling was frozen at Rs 3 lakh. During the same period, gratuity (a similar end-of-service benefit) had its non-government ceiling raised from Rs 10 lakh to Rs 20 lakh (2018) to Rs 25 lakh (2024). Inflation alone had eroded the Rs 3 lakh ceiling to approximately Rs 75,000 in real 1998 terms. Senior executives retiring in (say) 2022 with rupees twenty lakh of legitimate leave encashment found seventeen of those twenty lakh fully taxable -- a structural inequity widely litigated and widely criticised. The May 2023 notification was effectively a parity restoration -- aligning the leave encashment cap with the gratuity cap to reflect the comparable end-of-service nature of both benefits. |
2. The Notification 31/2023 Mechanics
Element | Specifics |
|---|---|
Notification Number | Notification No. 31 of 2023 dated 24 May 2023 |
Issuing Authority | Central Board of Direct Taxes; in pursuance of the Finance Act, 2023 amendment |
Effective Date | From 1 April 2023 onwards (applies to leave encashment received on or after this date) |
Applicable to | Non-government employees -- the four-limb test under sub-clause (10AA)(ii) operates with the new Rs 25 lakh as the second limb |
Lifetime Aggregate | The Rs 25 lakh ceiling is per employee, lifetime aggregate -- multi-employer encashment receipts cumulate |
No Retroactivity | Receipts before 1 April 2023 continue under the old Rs 3 lakh ceiling -- senior executives who retired in 2022-23 do not retroactively benefit |
3. Worked Example -- Senior Executive Pre vs Post Notification
Mrs. Anjali, age 60, retired from a private-sector multinational in March 2026. Last drawn salary basic + dearness allowance Rs 2 lakh per month. Average salary of last 10 months Rs 1.85 lakh per month. Leave at credit at retirement: 240 days (8 months at 30 days per year accumulated). Leave encashment received Rs 14.8 lakh.
Limb | Pre-1 April 2023 (old) | Post-1 April 2023 (new) |
|---|---|---|
(a) Actual leave encashment | Rs 14,80,000 | Rs 14,80,000 |
(b) Lifetime aggregate ceiling | Rs 3,00,000 (old) | Rs 25,00,000 (new) |
(c) 30-days × completed years × salary / 30 | Rs 16,00,000 | Same |
(d) 10 months' average salary | Rs 18,50,000 | Same |
Lower of (a)/(b)/(c)/(d) -- the exemption | Rs 3,00,000 (limb b governs) | Rs 14,80,000 (limb a governs; well within Rs 25 lakh cap) |
Taxable portion of encashment | Rs 11,80,000 | Nil |
Tax on Rs 11.80 lakh at 30% bracket + 4% Cess (without section 89 relief) | Approximately Rs 3.68 lakh | Nil |
With section 89 spread relief | Approximately Rs 1.5 lakh saving | Not needed |
The structural advantage for senior executives Mrs. Anjali's tax saving from the May 2023 notification is approximately Rs 3.68 lakh (the entire taxable portion under the old regime is now exempt). Across the cohort of senior executives retiring in 2024-26 with leave encashment of Rs 10-25 lakh, the aggregate tax saving is substantial. The May 2023 notification is one of the few unambiguous wins for HNI / senior-executive class in a budget cycle dominated by tax-tightening measures. Practitioners should explicitly highlight this when advising clients on retirement-date timing within the 2023-onwards window. |
4. Interaction with Section 89 Relief
Where leave encashment exceeds Rs 25 lakh (e.g., a top-bracket executive with 32 years of service and 360 days of leave at credit producing encashment of Rs 28 lakh), the excess Rs 3 lakh is taxable. Section 89 relief through Form 10E (RET-06) spreads the Rs 3 lakh across the past service years, materially reducing the cliff-edge tax. The combination of the new Rs 25 lakh ceiling plus section 89 relief on the residual eliminates almost all the leave-encashment cliff for typical senior executive retirements.
5. The Parity Argument and Future Expansions
The May 2023 notification reflects a particular interpretive principle -- that comparable end-of-service benefits should have comparable tax-exemption ceilings. This argument has implications for other areas where ceiling-restoration is overdue. Voluntary Retirement Scheme compensation under sub-clause (10C) of section 10 has a Rs 5 lakh ceiling unchanged since insertion; medical-treatment-abroad threshold under sub-clause (2)(viia) of section 17 read with proviso to Rule 3A was Rs 2 lakh until Finance Act, 2025 raised it to Rs 8 lakh -- partially addressing parity. The leave encashment expansion may signal a broader parity-driven calibration in coming Finance Acts.
6. Practitioner Documentation Discipline
- Confirm the date of leave encashment receipt -- on or after 1 April 2023 to qualify for the new Rs 25 lakh ceiling.
- Lifetime aggregate working -- where the assessee has received encashment from prior employers, sum cumulatively.
- Four-limb computation in client file -- actual / Rs 25L / 30-days × years / 10 months' average.
- If the encashment exceeds Rs 25 lakh, file Form 10E for section 89 relief on the excess.
- Schedule S entry in Income Tax Return; supporting computation documentary file for at least 8 assessment years.
7. Case Law Reference and Anticipatory Legal Analysis
Case Law Reference: The pre-2023 Rs 3 lakh ceiling jurisprudence The legacy Rs 3 lakh ceiling under sub-clause (10AA)(ii) of section 10 (applicable to non-Government employees pre-25 May 2023) generated extensive Tribunal jurisprudence on the four-limb computation -- principally on the meaning of 'average salary of the 10 months immediately preceding retirement' (whether basic + dearness allowance only, or all components forming part of salary). The Mumbai Tribunal in [VERIFY: confirm Tribunal citations on the salary-base for leave-encashment exemption -- e.g., proceedings on banking-sector officer encashment computation] generally upheld inclusion of all components forming part of 'salary' as defined in Rule 2(h) of Part A of the Fourth Schedule. The May 2023 ceiling enhancement to Rs 25 lakh does not displace this body of jurisprudence -- the four-limb computation continues to apply; only the second limb's ceiling has changed. [VERIFY: cross-check specific Tribunal citations in the BharatTax case-law database.] |
Prospective Interpretation -- The Rs 25 lakh aggregate-lifetime mechanic The May 2023 Notification 31/2023 specifies that the Rs 25 lakh ceiling is a lifetime aggregate -- where the assessee has received earlier tax-exempt encashment from prior employers (under the legacy Rs 3 lakh ceiling), those amounts must be aggregated and netted against the Rs 25 lakh ceiling for the current encashment. This raises three unsettled interpretive issues. (i) Whether the legacy Rs 3 lakh exempted amount is netted at its actual exempted figure or revalued at the new ceiling -- the literal text suggests the actual figure. (ii) Treatment of partial encashment received between 1 April 2023 and Notification date 25 May 2023 -- the Notification operates retrospectively from 1 April 2023, but the practitioner's documentary trail must establish the date of receipt for both the encashment and the prior-employer aggregation. (iii) Treatment of inter-employer transitions where the legacy encashment was claimed as exempt at the old ceiling but the new employer's encashment is claimed at the new ceiling -- the aggregation principle continues to apply. The BharatTax case-law database should monitor emerging Tribunal positions on these issues. [VERIFY: confirm Tribunal decisions emerging on the Notification 31/2023 framework.] |
8. Key Takeaways
- Central Board of Direct Taxes Notification No. 31/2023 dated 24 May 2023 raised non-government leave encashment ceiling from Rs 3 lakh to Rs 25 lakh effective 1 April 2023.
- Eight-fold expansion -- the rare exemption-expansion in a budget cycle dominated by tax-tightening measures.
- Parity restoration with gratuity ceiling (Rs 25 lakh post Finance Act, 2024).
- Lifetime aggregate per employee -- multi-employer receipts cumulate.
- No retroactivity -- pre-1 April 2023 receipts continue under the old Rs 3 lakh cap.
- Where encashment exceeds Rs 25 lakh, section 89 relief (RET-06) handles the residual.
Disclaimer: This article is for general information only. It does not constitute tax / legal advice. Please consult a qualified Chartered Accountant or tax practitioner for advice specific to your circumstances. The legal position is current as of FA 2024 (No. 2) / FA 2025; subsequent amendments and CBDT notifications may modify the position.