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) Section 10(10)(iii) gratuity ceiling raised from Rs 10L to Rs 20L (Notification No. 16/2019, S.O. 1213(E)) | Parity argument starts emerging -- why gratuity moves but leave encashment does not |
2024 (Central Government gratuity) | Gratuity limit for Central Government employees raised to Rs 25L; their gratuity is wholly exempt under section 10(10)(i), so the section 10(10)(iii) ceiling for other employees stays at Rs 20L | No change to the non-government ceiling |
May 2023 -- CBDT Notification 31/2023 | Rs 25 lakh (raised from Rs 3 lakh) | EIGHT-FOLD INCREASE; now above the Rs 20 lakh section 10(10)(iii) 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 under section 10(10)(iii) raised from Rs 10 lakh to Rs 20 lakh (Notification No. 16/2019, S.O. 1213(E)); the 2024 increase to Rs 25 lakh concerned Central Government employees, whose gratuity is wholly exempt under section 10(10)(i). 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 lifted the leave encashment limit to Rs 25 lakh, which now exceeds the Rs 20 lakh section 10(10)(iii) gratuity ceiling. |
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 second proviso to section 10(10AA)(ii) reduces the limit by any amount exempted in earlier years, and the first proviso caps the aggregate exemption where encashment is received from more than one employer in the same year -- so the Rs 25 lakh limit (Notification No. 31/2023) operates as a lifetime aggregate |
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) Notified ceiling (reduced by earlier exempt encashment under the proviso to section 10(10AA)(ii)) | 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; the gross-total-income threshold for the travel element of medical treatment abroad under clause (vi) of the proviso to section 17(2) was Rs 2 lakh until the Finance Act, 2025 made it a prescribed amount, now Rs 8 lakh under rule 3D -- 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 under the provisos to section 10(10AA)(ii) -- where the assessee has received exempt encashment from prior employers or in earlier years, those amounts reduce the Rs 25 lakh limit.
- 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 (ii) of section 10(10AA) applied to non-Government employees before Notification No. 31/2023. The exemption is the least of four limbs, and the Explanation to section 10(10) applies the meaning of 'salary' in Rule 2(h) of Part A of the Fourth Schedule to clause (10AA) as well. The enhancement of the ceiling to Rs 25 lakh does not change the four-limb computation; only the notified ceiling has changed. |
Prospective Interpretation -- The Rs 25 lakh aggregate-lifetime mechanic Notification No. 31/2023 raised the limit to Rs 25 lakh; the lifetime aggregation comes from the provisos to section 10(10AA)(ii) -- 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. |
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.
- The Rs 25 lakh leave encashment limit now exceeds the Rs 20 lakh section 10(10)(iii) gratuity ceiling (Notification No. 16/2019).
- Lifetime aggregate per employee under the provisos to section 10(10AA)(ii) -- earlier exempt receipts reduce the Rs 25 lakh notified limit.
- 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.