Kerala High Court on Leave Encashment Exemption for BSNL-Absorbed DoT Pensioners

Background and Parties

The Kerala High Court, in Sanchar Nigam Pensioners Vs Union of India, examined whether former employees of the Department of Telecommunications (DoT), later absorbed into Bharat Sanchar Nigam Limited (BSNL) and retired under its Voluntary Retirement Scheme – 2019, are entitled to full tax exemption on leave encashment under Section 10(10AA)(i) of the Income Tax Act, 1961.

  • The 1st petitioner: an association representing retired BSNL employees.
  • The 2nd and 3rd petitioners: individual members of this association who:
    • Initially served in DoT as Central Government employees.
    • Opted to be absorbed in BSNL upon its creation.
    • Subsequently retired under BSNL’s VRS-2019.

When their retirement dues were processed, BSNL deducted income tax at source on leave encashment, relying on a “Corporate Office Letter” (Ext.P11) issued by BSNL’s Deputy General Manager (Taxation). This instruction treated the petitioners as non-government employees for the purpose of leave encashment exemption.

The petitioners challenged:

  1. The legality of Ext.P11.
  2. The deduction of tax at source on leave encashment.
  3. The denial of exemption under Section 10(10AA)(i) applicable to Central/State Government employees.

They also sought directions enabling refund of tax already deducted and remitted, by permitting them to claim the correct exemption in their returns.

The High Court was required to determine:

  1. **Whether the leave encashment paid to the petitioners on retirement from BSNL is taxable under the head “Salaries” so as to attract TDS under Section 192 of the Income Tax Act 1961.
  2. Whether the petitioners fall under:
    • Section 10(10AA)(i) – applicable to “an employee of the Central Government or a State Government”, or
    • Section 10(10AA)(ii) – applicable to employees other than those of the Central/State Government, with a limited exemption ceiling.
  3. Whether BSNL could, through an internal instruction (Ext.P11), give an interpretation that effectively altered the statutory treatment of the petitioners’ leave encashment.

Statutory Framework Considered

1. TDS on Salaries – Section 192 of the Income Tax Act

The Court noted:

  • Section 192 requires deduction of tax at source from salary payments.
  • Pension is treated as salary for TDS purposes.
  • Crucially, Section 192 applies only if the payment is chargeable to tax under the head “Salaries”.

Key implication: If leave encashment is fully exempt under Section 10(10AA)(i), it is not taxable and TDS under Section 192 should not be applied.

2. Leave Encashment Exemption – Section 10(10AA)

The Court reproduced and examined Section 10(10AA), which provides:

  • Section 10(10AA)(i) – complete exemption for:

    “any payment received by an employee of the Central Government or a State Government as the cash equivalent of the leave salary… at the time of his retirement whether on superannuation or otherwise;”

  • Section 10(10AA)(ii) – partial exemption for:

    “any payment of the nature referred to in sub-clause (i) received by an employee, other than an employee of the Central Government or a State Government… in respect of so much of the period of earned leave… as does not exceed ten months… subject to such limit as the Central Government may… specify…”

The petitioners contended that:

  • Their status, for pensionary purposes, remained that of Central Government retirees, thereby attracting Section 10(10AA)(i).

BSNL and the Income Tax Department argued:

  • Since the petitioners retired from BSNL (a company) and not directly from Central Government service, they were covered only by Section 10(10AA)(ii) as non-government employees.

3. CCS (Pension) Rules, 1972 – Rule 37A