Leave Encashment

All employees get a certain number of leaves per year which they can avail during the financial year. These can be classified into casual leaves, sick leaves, privilege leaves , earned leaves or any other types of leaves as provided by the employer. In case an employee has unused leaves balance at the end of the year, some of these leaves can be carried forward to the next year as defined by the employer’s rules. Employees may also have an option to encash the unused leaves instead of taking holidays. This process of encashing the leaves is known as Leave Encashment.

Types of Leaves:

Casual Leave : This is the most common type of leaves available to an employee and can be taken for a maximum period of seven days at a stretch (depending on the policies of the employer). They can be considered for leave encashment if they are allowed to be carried forward according to company’s policies.

Privilege or Earned Leave : Employee can avail an earned leave after giving prior notice to the employer. The employee is generally paid during these leaves. If the employee does not avail this leave, they become eligible for leave encashment after a specific period {generally one year}. However, policy can vary from one organization to another.

Medical Leave : If employee is unable to carry out his duties due to health conditions, they must inform the employer of these leaves. They are generally paid leaves when approved by the employers. However, the compensation and maximum number of leaves can vary from one organization to another.

Maternity Leave : Maternity leaves are paid leaves only available for female employees and can range from 12 to 26 weeks during or after pregnancy. These leaves are not eligible for leave encashment.

Sabbatical Leave : Employees can take leaves for upskilling or expanding their knowledge bases. They can participate in any workshop or training related to their line of employment, as well as enroll in long-term courses at universities.

Taxability of Leave Encashment

Leave Encashment received during employment

If an employee receives leave encashment during the period of their employment, that amount becomes fully taxable in the hand of the employee under the head “Income from Salaries”.

Leave Encashment received at the time of resignation or retirement

Received by Government employees: Leave encashment received by government employees at the time of retirement is fully exempt from tax.

Received by Legal heir of a deceased employee: Leave encashment received by the legal heir of a deceased employee if fully exempt from tax in the hands of legal heir.

Received by non-government employees: Leave encashment received by non-government employees at the time of retirement or otherwise is exempt from tax to the extent of the least of the following:

• (i) Actual leave encashment received
• (ii) Last 10 months average salary (calculated based on average salary drawn during the 10 months immediately preceding the retirement or resignation)
• (iii) Cash equivalent to unused leaves based on daily salary ( considering maximum 30 days of leaves per year ) for every year of completed service
• (iv) Maximum amount notified by the government i.e. Rs. 25,00,000.

Illustration for Understanding

Mr. Ayush is resigning after 15 years of service. Mr. Ayush was entitled to maximum 35 days leaves per annum from his employer i.e. overall 525 days of leave during his service period ( 35 days * 15 years )

Out of the same, he has already utilized 200 days of paid leaves and is left with 325 days of unutilized leaves.

Mr. Ayush was drawing basic salary + dearness allowance of Rs. 45,000 per month at the time of retirement and received Rs. 4,87,500 as leave encashment based on 325 days * Rs. 1,500 (Salary per day = Rs. 45,000 / 30 days )

Following is the calculation of leave encashment taxability