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What is Leave Encashment?
Leave encashment is the process of calculating and crediting the amount of cash in exchange for an employee’s unused paid leaves. Employees can save their leaves to receive money when they leave their job or retire. Leave encashment is included in the employee’s full and final settlement.
The leave encashment policy differs from company to company, and the rules vary. Some companies usually pay for the leaves taken, or some adjust them in the next calendar year.
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Types of Leaves
To encash your leaves, you need to know the types of leaves, and which of them can be encashed. Here are different types of leaves:
| Leave Type | Description | Eligibility for Encashment |
| Casual Leave | Commonly used leave with a duration of 7 to 10 days. Must inform employer for encashment. | Eligible |
| Privilege Leave | Requires prior notice and varies by organization. Eligible for encashment after a period. | Eligibility varies |
| Medical Leave or Sick Leave | For health conditions, requires employer notice. Eligible for encashment, but not long-term. | Eligible (Excluding long-term) |
| Sabbaticals | For upskilling, paid and reimbursed by the organization. Eligible for encashment. | Eligible |
| Holiday Leaves | Paid leaves, no salary deduction. Eligible for encashment. | Eligible |
| Maternity Leave | Available to pregnant employees, varies in duration. Not eligible for encashment. | Not eligible |
| Compensatory Leave / Comp Off | Comp off is paid time off given to employees in exchange for working overtime or on holidays. | Not eligible |
| Floater Leave | A short period of leave an employee can take on a chosen workday, subject to company approval. | Eligibility varies |
| National Holiday | A designated paid day off to commemorate a national event. | Not eligible |
| Marriage Leave | Paid leave granted to an employee specifically for getting married. | Not eligible |
| Unpaid Leave | A period of leave an employee takes without receiving regular pay. | Not eligible |
Is Leave Encashment Taxable?
Any leave is available for encashment during service or at the time of retirement, or when a person resigns. When encashed during the service period, it is fully taxable and part of the salary income. However, one can claim some relief under Section 89 of the Income Tax Act.
Leave Encashment During Employment
Leaves encashed while the employee is still employed are subject to taxation since the amount encashed becomes part of the “income from salary” head.
Tax benefits under Section 89 apply to this head, and employees can save tax by filling out Form 10E to claim tax relief.
Leave Encashment At Retirement or Resignation
When any leave is encashed at retirement or resignation, one can avail of certain partial and complete exemptions. The conditions for exemption are:
- For employees of the Central or State Government, the leave encashment is exempted from taxation.
- Leaves are fully exempted when any legal heir has received the encashment on behalf of a deceased employee.
- In the case of government employees, leave encashment is exempt based on the computation provided in Section 10 (10AA) ii, which includes the balance of taxable income from salary, if any.
Leave Encashment Formula
The formula to calculate leave encashment amount:
[(Basic Salary + Dearness Allowance)/30] x Number of Earned Leaves
Leave Encashment Calculation
To understand how the leave encashment is calculated, here is an example:
Mrs Shanaya is retiring after 20 years of service. She was entitled to 25 days of paid leave per annum from her company, meaning she had 500 days of leave during her entire service to the company.
Out of this, Mrs Shanaya has already utilised 150 days of paid leave. She is left with 350 days of unutilised leave.
Now, as for her salary, she is drawing a basic salary plus a dearness allowance (DA) of Rs 35,000 per month at the time of retirement.
Now, leave encashment is calculated based on the number of unutilised leaves multiplied by salary per day, which would be calculated as:
Salary per day = 35,000/30 = Rs. 1167 (approx)
Leave encashment received = 350*1167 = 4,08,450
Thus, Mrs Shanaya received an amount of Rs 4,08,450 as leave encashment.
| Particulars | Amount in Rs |
| Leave encashment received | 4,08,450 |
| Tax exemption: least of the following
1. Amount notified by the government 2. Actual leave encashment 3. Average salary for 10 months (35000*10) 4. One day salary multiplied by (30* completed years of service minus unutilised days of leave i.e.,= 1167* (30*20 – 150) |
3,00,000 4,08,450 3,50, 000 5,25,150 |
| Exemption (Leave encashment received minus 3,00,000 (since it’s the least of the above i.e., Rs. 4,08,450 – Rs. 3,00,000) | 1,08,450 |
| Leave encashment taxable as ‘income from salary’ | 1,08,450 |
Process of Leave Encashment
Leave encashment allows employees to convert their unutilized paid leave days into monetary compensation. The specific process can vary depending on the company’s leave policy, but here’s a general breakdown:
Accumulation of Unused Leaves
The employee ends the year with a certain amount of unused leaves which are eligible for encashment.
Initiating the Request
The employee submits a formal request which may involve filling out a leave encashment form or submitting a written request to HR.
Calculation and Approval
The HR department will calculate the encashment amount based on your company’s policy. This often involves multiplying your daily salary (basic pay + dearness allowance) by the number of days being encashed.
Your manager or HR might need to approve the request based on operational needs and your leave balance.
Monetary Valuation & Payment
Once approved, the encashment amount will be included in your final salary or paid out separately depending on company policy. Taxes are also deducted from this final payment if applicable.
Automated Leave Encashment Calculation
The longer an employee works for a company, the more complex the calculations for leave encashment become. Leave all the tedious calculation work to RazorpayX Payroll and focus on what you do the best – managing your business!
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FAQs
1. Are leave salary and leave encashment the same?
Leave salary, which is accumulated over time and encashed later, is leave encashment. Leave salary is, thus, a part of leave encashment.
2. Is leave encashment taxable?
Yes, leave encashment is taxable. However, the taxation conditions differ in the sector one is employed in and the terms and conditions set by the employer.
3. How is leave encashment calculated?
Leave encashment is calculated with the following formula. = [(Basic Salary + Dearness Allowance) / 30] * No of EL Here, EL= Earned leave. Read more details in the example provided in the blog.
What is the maximum number of leaves that an employee can encash?
The specific number of leaves that can be encashed varies from company to company. Make sure to check your company's leave policy to understand this further.
Can casual leaves, sick leaves, etc., be encashed?
Casual leave is eligible to be encashed, but depends heavily on the leave policy of the company. The same applies for sick leaves and other kinds of leaves. You can reach out to your HR to understand your company's policy on leave encashment.
Is leave encashment taxable after termination?
Leave encashment after termination can be taxable. The exact tax treatment depends on your country's regulations and your company's policy. It's best to consult your HR department or a tax professional for clarification.
