Leave Encashment
Understanding Leave Encashment
In this post, we will discuss the concept of leave encashment, its types, and when employees can get it. We’ll also explore the calculation methods, tax implications, and exemptions associated with leave encashment, providing a clear understanding of this significant employee benefit.
Let’s look at these sections in detail:
What is leave encashment?
Leave encashment is the amount that an employee receives for unused paid leave. While leave is mandatory, Indian labour regulations do not force employers to cash out extra leave. Employers can determine whether unused leave should be redeemed or carried forward. According to studies, approximately 10% of paid leave is unused annually. Offering leave encashment can help employees and improve employee satisfaction.
Different Types of Leaves?
- Casual Leave:
Employees can take this leave for up to seven days at a time, subject to the employer’s policy. Prior notice is usually required. Casual leave may be encashed if the company allows it to be carried forward. - Privilege Leave:
This paid leave requires prior approval and can often be accumulated and encashed later, depending on company rules. - Medical Leave:
This one is used when employees are unwell. No prior notice is needed, and the Number of days allowed varies by organisation. This leave is usually paid. - Maternity Leave:
This paid leave, which is usually granted to pregnant employees, lasts between 12 and 26 weeks. - Sabbatical Leave:
Offered to employees for professional development, such as attending courses, workshops, or training related to their job. - Quarantine Leave:
This one is provided when an employee needs to be isolated due to an infectious disease in their family or community. This leave is not eligible for encashment. - Paternity Leave:
Available to new fathers, this leave is primarily offered to government employees in India, usually for 15 days before or after the birth of a child. It is not encashable.
- Casual Leave:
When can an employee avail leave encashment?
- During the tenure of a service
- At the time of retirement
- Termination of the service
Leave encashment calculation
Let’s assume Rajesh retired after working 20 years at a private company. At the time of his retirement, his basic Salary was ₹1,20,000 per month. The company allowed employees 20 days of paid leave per year. Out of the total 400 paid leave days Rajesh earned, he used 50 days and had 350 days of unused leave at retirement.
The leave encashment amount is calculated using this formula:
Encashed amount = Basic salary per day × Number of unused earned leaves
In Rajesh’s case:
Encashed amount = (₹1,20,000 ÷ 30) × 350 = ₹4,000 × 350 = ₹14,00,000
So, Rajesh will receive ₹14 Lakhs as his leave encashment amount.
Since Rajesh is a non-government employee, his leave encashment is partially exempt from tax as per Section 10(10AA)(ii) of the Income Tax Act. The exact exemption will depend on specific tax calculations.
Is the leave encashment amount taxable?
Leave encashment is taxed based on when it is received:
- While employed: The full amount is taxable as salary income for both government and private employees. However, tax relief can be claimed under Section 89 of the Income Tax Act.
- Upon death: If the legal heir receives the amount, it is fully exempt from tax.
- At retirement or resignation:
- For Central and state government employees: Fully exempt from tax.
- For private employees: Partially exempt under Section 10(10AA)(ii), with the remaining amount taxed as salary income.
Tax exemptions on Leave encashment
The tax exemption for leave encashment is determined by the least of the following:
- Actual amount received from the organization
- Average salary (basic + dearness allowance) for the last 10 months
- Cash equivalent of unused earned leave
- Maximum limit set by the government, which is 25 lakhs.
For example :
Rajesh received Rs. 14 lakhs from his organization at the time of exit. His average salary over the last 10 months was Rs. 12 lakhs (Rs. 1,20,000 x 10).
The cash equivalent of his unused leave is calculated by multiplying the daily salary with the unused leave days for each year of service, capped at 30 days per year. For Rajesh, this amount is:
(Rs. 1,20,000 ÷ 30) x ((30 x 20) – 200) = Rs. 16 lakhs.
The tax exemption on Rajesh’s encashed amount will be the lowest of any of the following values:
Actual amount collected from the organization. | Rs. 14 Lakhs |
Average income over the last 10 months | Rs. 12 Lakhs |
Cash equivalent of unused earned leave | Rs. 16 Lakhs |
The government set the maximum limit. | Rs. 25 Lakhs |
The least amount from the above four values is Rs. 12 Lakhs, so this is the exempted amount under Section 10(10AA)(ii).
The taxable amount is calculated by deducting the lower value from the lump sum provided by the organization. Rajesh’s taxable leave encashment is:
Leave encashment received | Rs. 14 Lakhs |
Exempted amount | Rs. 12 Lakhs |
Taxable amount | Rs. 2 Lakhs |
This Rs. 2 Lakhs will be added to Rajesh’s salary income and taxed as per the applicable slab.
And with that, we’ve completed this post on leave encashment. Please leave any questions or comments in the space below, and we are ready to assist.
FAQs
1. Are leave encashment and leave salary equal?
Ans: Leave Salary is a type of leave encashment that accumulates over time and can be redeemed later.
2. Is leave encashment taxable?
Ans: Leave encashment is taxed. However, tax conditions vary by sector and employer.
3. Are all kinds of leaves eligible for encashment?
Ans: Only Earned Leave (EL) is usually eligible for encashment. Some companies may also offer the encashment of Privilege Leave (PL).
