I-T move on leave encashment to affect revenue

In a move that could impact organisations across all sectors, the Income Tax (I-T) Department has disallowed expenses towards leave encashment and gratuity as deduction when calculating taxable income.

Explaining the move, department officials said: “Both are provisions or expenses which are actually not incurred. They are set aside to meet future liabilities as and when they occur.” Therefore, they added, deductions on all such expenses and provisions are being disallowed in the returns filed 2008-09 onwards. “The decision is expected to affect all organisations and have huge revenue implications,” the officials said.

Till now, deductions under leave encashment and gratuity were covered under Section 43B of I-T Act. The other such expenses, which are allowed as expenses to be deducted from taxable income are contribution to provident fund, payments made to government, etc.

The I-T officials said, henceforth, expenses and provisions towards leave encashment and gratuity will be considered as deductions from taxable income only on actual basis. This means both will be allowed as deductible expenses only when they are actually paid to the employees.

Under Section 4 of the Payment of Gratuity Act 1972, gratuity is paid by the employer to an employee as a mark of recognition of the service rendered by the person. It is given on retirement, death or resignation after five years of continued service.

Similarly, leave encashment is the amount payable for the employee’s leave period, depending on the leaves to his credit and his salary at the time of termination of employment. The amount may be paid to the employees (or to their dependents) on retirement, death or disability.

Before 2008-09, deduction towards leave encashment and gratuity was a controversial issue following a Calcutta High Court judgment in the case of Exide Industries. The court ruled in favour of Exide and against the revenue department, saying that such provisions whether paid or not were eligible for deductions on the basis of actuarial valuation. A stay was announced in 2008 for 2008-09 returns assessed in the current financial year.

In response to the high court ruling, the I-T Department filed a special leave petition in Supreme Court, which stayed the judgment. The revenue department, based on this stay, has disallowed the expenses towards leave encashment and gratuity as deduction when calculating taxable income.

Tax experts said while the department will benefit more in terms of revenue, most of the assessees will go on appeal.