Gratuity and leave encashment exemption computed on basic pay plus dearness allowance; other allowances are excluded.

For exemption of gratuity and leave encashment under Sections 10(10) and 10(10AA) of the Income-tax Act, "salary" is governed by the Explanation to Section 10(10), which adopts Rule 2(h) of Part A of the Fourth Schedule. Under that rule, only dearness allowance is included, and only where the terms of employment so provide; other allowances and perquisites are excluded. The broader definition of salary in Section 17 does not apply to these exemption provisions. On that construction, exempt amounts are computed on basic pay plus dearness allowance alone, and the issue is decided against the assessee and in favour of the Revenue.

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Issues: Whether, for computing exemption on gratuity and leave encashment under Sections 10(10) and 10(10AA) of the Income-tax Act, 1961, "salary" includes allowances other than dearness allowance and whether the appellate authorities were right in applying the definition in Rule 2(h) of Part A of the Fourth Schedule.

Analysis: The expression "salary" in Sections 10(10) and 10(10AA) is controlled by the Explanation to Section 10(10), which adopts the meaning assigned in Rule 2(h) of Part A of the Fourth Schedule. That rule includes dearness allowance only if the terms of employment so provide and excludes all other allowances and perquisites. The general definition of salary in Section 17 does not govern these exemptions. The authorities below therefore correctly computed the exempt amounts on the basis of basic pay plus dearness allowance alone, and the cited Madras High Court decision supports the same construction.

Conclusion: The issue is decided against the assessee and in favour of the Revenue.

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