The Assessing Officer has swept my gratuity and leave encashment payments into the s.35DDA five-year spread along with the VRS compensation. Must terminal benefits be amortised too?
No. The Gujarat High Court held that gratuity and leave encashment are post-retirement benefits accruing from actual service rendered, payable whether retirement is voluntary or on superannuation, and are ancillary to — not part of — the voluntary retirement scheme. Only the VRS compensation component falls into the one-fifth spread under s.35DDA; the terminal benefits are deductible in full.
Decided by the High Court (A.S. Supehia J and Pranav Trivedi J) on 2026-03-12, reported as R/Tax Appeal No.640 of 2022 with R/Tax Appeal No.113 of 2023, High Court of Gujarat at Ahmedabad; assessment year 2001-02; reserved 18 February 2026, pronounced 12 March 2026. It bears on section 35DDA, section 37(1), section 43B, section 43B(b), section 43B(f), section 260A of the Income Tax Act 1961, in Deductions & Disallowances, Salary & Perquisites and Appeals matters.
This is the practical fight in almost every VRS assessment, because the employer's cheque to a retiring employee bundles compensation for the unexpired service with gratuity and leave encashment, and the Assessing Officer amortises the lot. The Court's test is the source of the entitlement, not the occasion of payment: gratuity and leave encashment are earned by service and would have been payable on ordinary retirement, so they are not 'in connection with his voluntary retirement' within s.35DDA(1). Two supporting points in the judgment matter to practitioners. The Court held the CIT(A) was wrong to fault the assessee for not producing an agreement he was never asked by the Assessing Officer to produce. And it rejected the CIT(A)'s use of s.43B(f), holding that gratuity fell within s.43B(b) and that the insertion of s.43B(f) with effect from 1 April 2002 does not make pre-2002 leave encashment inadmissible. Read this alongside CIT v State Bank of Mysore (Karnataka High Court, 2013), also in this library, which is the mirror image: there the taxpayer wanted the whole payment allowed in one year and was held to the one-fifth.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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For AY 2001-02 the assessee paid Rs 1,77,62,048 as gratuity under the Payment of Gratuity Act, Rs 30,93,624 as leave encashment and Rs 4,77,96,977 at the time of voluntary retirement under a VRS dated 12 February 2000. It claimed one-fifth of Rs 4,77,96,977 under s.35DDA and claimed the gratuity and leave encashment in full as expenses laid out wholly and exclusively for the purposes of business. The Assessing Officer held that one-fifth of the entire aggregate of Rs 6,86,52,649 was eligible under s.35DDA and that the gratuity and leave encashment were not separately allowable. The Commissioner (Appeals) and the Tribunal upheld that, the Commissioner (Appeals) rejecting the assessee's contention on the ground that no agreement or contract between the assessee and its employees had been produced, and relying additionally on s.43B(f), which was introduced with effect from 1 April 2002, to hold the leave encashment inadmissible. The total disallowance in issue on this ground was Rs 5.49 crores. The Court called for and examined the VRS dated 12 February 2000.
Both the Commissioner (Appeals) and the Tribunal had taken an erroneous view, and substantial question of law (a) was answered in favour of the assessee and against the Revenue (para 11). Gratuity and leave encashment paid at the time of voluntary retirement are ancillary post-retirement benefits accruing from the actual service rendered by the employee and cannot be said to be part of the VRS; only the compensation payable under the VRS falls to be amortised at one-fifth under s.35DDA (para 10). Tax Appeal No.640 of 2022 was allowed and the Tribunal's order quashed and set aside (para 28).
The Court examined the recitals of the VRS and found that the employees were paid compensation for the remaining period of service and that, apart from the other benefits under the scheme, they were paid gratuity as per the Payment of Gratuity Act and leave encashment. It held that although those amounts are paid at the time of voluntary retirement, they are ancillary benefits paid on voluntary retirement or on retirement generally. The intent of s.35DDA is that the expenditure be paid to an employee in connection with his voluntary retirement under a scheme of such retirement, and on fulfilment of those conditions one-fifth falls for allowance in the year of payment with the balance in four equal annual instalments. There were two components in this VRS: compensation to employees who opt for VRS, and gratuity and leave encashment for service rendered to which an employee is otherwise entitled on retirement, whether voluntary or on superannuation. Those benefits are governed by the respective rules or clauses of employment and are post-retirement benefits accruing from actual service. The Assessing Officer's approach of restricting the whole claim to one-fifth was therefore erroneous, and the Commissioner (Appeals) had wrongly rejected the bifurcation for want of an agreement the Assessing Officer had never called for (para 10). On s.43B, the Court held that gratuity fell within s.43B(b) and that the introduction of s.43B(f) with effect from 1 April 2002 did not render pre-insertion leave encashment inadmissible (para 10).
Thus, the benefit of gratuity and leave encashment are the post-retirement benefits accruing from the actual service rendered by an employee.
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Handle my notice → Ask a CA on WhatsAppNo. The Gujarat High Court held that gratuity and leave encashment are post-retirement benefits accruing from actual service rendered, payable whether retirement is voluntary or on superannuation, and are ancillary to — not part of — the voluntary retirement scheme. Only the VRS compensation component falls into the one-fifth spread under s.35DDA; the terminal benefits are deductible in full. This was decided by the High Court (A.S. Supehia J and Pranav Trivedi J) and bears on section 35DDA, section 37(1), section 43B, section 43B(b), section 43B(f), section 260A of the Income Tax Act 1961. It is reported as R/Tax Appeal No.640 of 2022 with R/Tax Appeal No.113 of 2023, High Court of Gujarat at Ahmedabad; assessment year 2001-02; reserved 18 February 2026, pronounced 12 March 2026. This is the practical fight in almost every VRS assessment, because the employer's cheque to a retiring employee bundles compensation for the unexpired service with gratuity and leave encashment, and the Assessing Officer amortises the lot. The Court's test is the source of the entitlement, not the occasion of payment: gratuity and leave encashment are earned by service and would have been payable on ordinary retirement, so they are not 'in connection with his voluntary retirement' within s.35DDA(1). Two supporting points in the judgment matter to practitioners. The Court held the CIT(A) was wrong to fault the assessee for not producing an agreement he was never asked by the Assessing Officer to produce. And it rejected the CIT(A)'s use of s.43B(f), holding that gratuity fell within s.43B(b) and that the insertion of s.43B(f) with effect from 1 April 2002 does not make pre-2002 leave encashment inadmissible. Read this alongside CIT v State Bank of Mysore (Karnataka High Court, 2013), also in this library, which is the mirror image: there the taxpayer wanted the whole payment allowed in one year and was held to the one-fifth. If it applies to you, the first step is this: Bifurcate the VRS payout in the computation and on the record: compensation for the unexpired period of service on the one hand, gratuity and leave encashment on the other, with the basis of each stated.
For AY 2001-02 the assessee paid Rs 1,77,62,048 as gratuity under the Payment of Gratuity Act, Rs 30,93,624 as leave encashment and Rs 4,77,96,977 at the time of voluntary retirement under a VRS dated 12 February 2000. It claimed one-fifth of Rs 4,77,96,977 under s.35DDA and claimed the gratuity and leave encashment in full as expenses laid out wholly and exclusively for the purposes of business. The Assessing Officer held that one-fifth of the entire aggregate of Rs 6,86,52,649 was eligible under s.35DDA and that the gratuity and leave encashment were not separately allowable. The Commissioner (Appeals) and the Tribunal upheld that, the Commissioner (Appeals) rejecting the assessee's contention on the ground that no agreement or contract between the assessee and its employees had been produced, and relying additionally on s.43B(f), which was introduced with effect from 1 April 2002, to hold the leave encashment inadmissible. The total disallowance in issue on this ground was Rs 5.49 crores. The Court called for and examined the VRS dated 12 February 2000. The matter was decided on 2026-03-12 by the High Court (A.S. Supehia J and Pranav Trivedi J). On those facts the High Court held as follows. Both the Commissioner (Appeals) and the Tribunal had taken an erroneous view, and substantial question of law (a) was answered in favour of the assessee and against the Revenue (para 11). Gratuity and leave encashment paid at the time of voluntary retirement are ancillary post-retirement benefits accruing from the actual service rendered by the employee and cannot be said to be part of the VRS; only the compensation payable under the VRS falls to be amortised at one-fifth under s.35DDA (para 10). Tax Appeal No.640 of 2022 was allowed and the Tribunal's order quashed and set aside (para 28).
The Court examined the recitals of the VRS and found that the employees were paid compensation for the remaining period of service and that, apart from the other benefits under the scheme, they were paid gratuity as per the Payment of Gratuity Act and leave encashment. It held that although those amounts are paid at the time of voluntary retirement, they are ancillary benefits paid on voluntary retirement or on retirement generally. The intent of s.35DDA is that the expenditure be paid to an employee in connection with his voluntary retirement under a scheme of such retirement, and on fulfilment of those conditions one-fifth falls for allowance in the year of payment with the balance in four equal annual instalments. There were two components in this VRS: compensation to employees who opt for VRS, and gratuity and leave encashment for service rendered to which an employee is otherwise entitled on retirement, whether voluntary or on superannuation. Those benefits are governed by the respective rules or clauses of employment and are post-retirement benefits accruing from actual service. The Assessing Officer's approach of restricting the whole claim to one-fifth was therefore erroneous, and the Commissioner (Appeals) had wrongly rejected the bifurcation for want of an agreement the Assessing Officer had never called for (para 10). On s.43B, the Court held that gratuity fell within s.43B(b) and that the introduction of s.43B(f) with effect from 1 April 2002 did not render pre-insertion leave encashment inadmissible (para 10). In the words reproduced by the source cited on this page: "Thus, the benefit of gratuity and leave encashment are the post-retirement benefits accruing from the actual service rendered by an employee."
It was decided by the High Court on 2026-03-12 and is reported as R/Tax Appeal No.640 of 2022 with R/Tax Appeal No.113 of 2023, High Court of Gujarat at Ahmedabad; assessment year 2001-02; reserved 18 February 2026, pronounced 12 March 2026. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 35DDA, section 37(1), section 43B, section 43B(b), section 43B(f), section 260A, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. Both the Commissioner (Appeals) and the Tribunal had taken an erroneous view, and substantial question of law (a) was answered in favour of the assessee and against the Revenue (para 11). Gratuity and leave encashment paid at the time of voluntary retirement are ancillary post-retirement benefits accruing from the actual service rendered by the employee and cannot be said to be part of the VRS; only the compensation payable under the VRS falls to be amortised at one-fifth under s.35DDA (para 10). Tax Appeal No.640 of 2022 was allowed and the Tribunal's order quashed and set aside (para 28). It arises in Deductions & Disallowances, Salary & Perquisites and Appeals matters, on section 35DDA, section 37(1), section 43B, section 43B(b), section 43B(f), section 260A of the Income Tax Act 1961, and was decided by A.S. Supehia J and Pranav Trivedi J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Show that gratuity and leave encashment are governed by the rules or clauses of employment and would have been payable on superannuation as well — that is the finding the Court acted on. Claim only the compensation component under s.35DDA at one-fifth, and claim the terminal benefits separately, subject to the payment condition in s.43B. If the Commissioner (Appeals) rejects the bifurcation for want of an agreement or contract, check whether the Assessing Officer ever called for it; the Court held the assessee could not be penalised for not producing what was never asked for. For years up to AY 2001-02, resist the use of s.43B(f) on leave encashment: the Court held its insertion with effect from 1 April 2002 does not disallow pre-insertion leave encashment.
Searched for later treatment; none was found. That is not the same as a source affirming it. Two searches, nothing found. The citedby search on the doc id is empty. A search combining the party name with '35DDA' returns two results: this judgment and the Ahmedabad Tribunal's order of 25 May 2022 in the Revenue's appeal, which is earlier. No later decision has adopted, doubted or distinguished the holding that gratuity and leave encashment are post-retirement benefits accruing from actual service, payable whether retirement is voluntary or on superannuation, and so are ancillary to rather than part of a voluntary retirement scheme payment governed by s.35DDA. Whether the Revenue has carried the matter to the Supreme Court could not be established; nothing appeared. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
This judgment disposes of cross appeals raising four questions (a) to (d) covering the VRS payments, a Rs 25 crore receipt on transfer of trademarks, goodwill and s.41(1); only question (a) is covered by this entry. The judgment runs to 28 numbered paragraphs and the disposal at para 28 was read: Tax Appeal No.640 of 2022 allowed, the Tribunal's order quashed and set aside, Tax Appeal No.113 of 2023 dismissed. The judgment is very recent (12 March 2026) and pages carry the court's own 'NEUTRAL CITATION' watermark; no law-report citation exists yet so far as I could see. The assessment year is 2001-02, which is the first year of s.35DDA's operation. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
Both the Commissioner (Appeals) and the Tribunal had taken an erroneous view, and substantial question of law (a) was answered in favour of the assessee and against the Revenue (para 11). Gratuity and leave encashment paid at the time of voluntary retirement are ancillary post-retirement benefits accruing from the actual service rendered by the employee and cannot be said to be part of the VRS; only the compensation payable under the VRS falls to be amortised at one-fifth under s.35DDA (para 10). Tax Appeal No.640 of 2022 was allowed and the Tribunal's order quashed and set aside (para 28).
TaxSphere, “Ambalal Sarabhai Enterprises Ltd v DCIT”, https://taxnotice.vittsphere.com/caselaw/case/ambalal-sarabhai-gratuity-and-leave-encashment-are-not-vrs-payments/ (validity last checked 2026-09-08)
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