Leave Encashment Calculation – Tax Exemption & Other Rules

Leave encashment is the amount of money an employee receives from an employer for their unutilised leaves.

But how exactly are leaves to be encashed calculated? Is leave encashment taxable? When can leaves be encashed?

This blog post answers all these questions and more. Read on to learn all about it.

What is leave encashment?

According to this policy, the employer is responsible for clearing the employee’s dues for the services provided via cash or adjusting these in the leaves quota for the next calendar year. 

To simplify, encashment means this leave balance can be availed by the company’s employees when they retire, leave the job, or continue their service. An employee’s leave encashment is included in the full and final settlement the company performs upon their resignation or termination. 

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. However, the amount of unavailed leaves and bonuses must be settled by the 7th or 10th of the following month after resignation, according to the 1948 Factories Act.

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:

1. Casual Leave

It is the most commonly used leave by employees. The duration varies from company to company, but a minimum of 7 to 10 days is usually allowed. The specific policy is available with the organisation, and the employee must inform the employer about their casual leave along with the duration and date of joining back. If this is accepted, your leave will be eligible for cash encashment. 

2. Privilege Leave

A privilege leave is one that an employee can avail of when prior information is provided to the employee, and the leave is sanctioned. It becomes eligible for encashment after a specific period, though the policy for privilege leave encashment differs from organisation to organisation.

3. Medical Leave

Employees can avail of medical leave if they cannot work because of their health conditions. For this, they need to inform the employer about pending leaves. Once sanctioned, these become eligible for leave encashment. The number of leaves that are allowed differs from the organisation. However, the long term medical leaves don’t fall under the cash leave encashment window. 

4. Sabbaticals

Another type of leave that employers give to employees is for upskilling and expanding their knowledge. These can be done through several courses. These are paid leaves, and an organisation reimburses them, and they are considered for leave encashment.

5. Holiday Leaves

Holiday leaves are also paid leaves, and no amount is cut from an employee’s salary. These are also eligible for leave encashment. 

6. Maternity Leave

Maternity leave is available to all pregnant female employees during the term of their employment. It may span from 12 weeks to 26 weeks of pregnancy. This can be extended, but there is no payment for the extended period. The maternity leave policy also differs across organisations. These are not considered for encashment. 

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 is a part of the income from salary. However, one can claim some relief under Section 89 of the Income Tax Act.

Conditions of exemption

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 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. 

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