Leave Encashment in India: Meaning, Rules, Exemption and Calculation

What is Leave Encashment?

Leave encashment is a process whereby the employee utilises all the accumulated leaves and receives remuneration in exchange for that. These leaves need to be paid/earned leaves only, and not unauthorized leave. The leave reimbursement is often incorporated into the contract made between the employee and the employer, and takes into account several factors such as leave balance, leaves taken and sick leave. In India, it is according to the company policies that these leaves are decided and adjusted.

Types of Leaves in India

Generally, in India, there are multiple leave types that one might encash as per the company policy. The most common types are:

• Casual Leave (CL): Casual leaves are applied in the case an employee is absent for a short-term, mostly due to personal reasons.
• Sick Leave (SL): In case an employee falls sick, a sick leave is granted for allowing the employee to recover and rejoin the organization. Sick leaves can vary from a day to a month, depending on the intensity of the disease/disorder.
• Earned Leave (EL): Every employee is entitled to earned leaves monthly, which they can encash depending on company terms and policies.
• Maternity Leave: This leave is granted by an organization to its female employees for all pre and post-maternity events.
• Paternity Leave: There are varied leave encashment rules pertaining to their usage, accruals, and encashments, which may vary from one organization to another.
• Marital Leave: A marital leave is allowed for employees who will be soon marrying. The leave duration depends on a discussion and mutual agreement between the organisation and the employee The eligibility rules for leave encashment in India is presented below:

How to Calculate Leave Encashment?

The computation of leave reimbursement is fairly easy to understand. The formula used is as follows:

Leave Encashment = (Number of Unused Leaves) × (Basic Salary + Dearness Allowance/30)

Here, basic Salary is divided by 30 working days - based on the assumption that the total employment days for the employee is 30 days. For example, suppose an employee has 10 days of unused leave and the basic salary is ₹30,000 monthly, which includes dearness allowance. The leave payout can be calculated as: Leave Encashment = 10 × (30,000/30) = ₹10,000

The above encashed amount will be incorporated into the salary of the employee in the month in which encashment occurs.

However, there are certain exemptions in the case of leave payout as provided under the Indian Income Tax Act. According to Section 10A(10AA), the threshold for leave pay follows to: For employees working under the Central Government - the total amount of leave reimbursement is exempted from tax and upon retiring, a Central Government employee can claim 100% tax exemption on leave payout For non-government employees - The salary is exempt up to the least of the following-three:

• Leave reimbursement claimed.
• The amount according to the formula will be computed as: (Number of days of leave encashed) * (Average of the previous 10 months' salary just before the month in which encashment occurs)/30.
• ₹ 25,00,000 as notified by the government

Leave Encashment Exemption Under Income Tax Act

Example

In a case where a non-governmental employee encashes their leave balance for 15 days on an average for the past 10 months, the individual receives ₹45,000 as remuneration. The tax exemption on it can be calculated as follows: Tax exemption = 15 x (45,000 / 30) = ₹22,500 This implies that the employee is entitled to claim a total tax exemption of ₹22,500 on the remuneration of ₹45,000.

Is Leave Encashment Taxable?

The taxable nature of leave reimbursement depends on the status of the employee and the case regarding his/her encashment.

Taxability for Government Employees

In the case of the central government employees, any leave payout received at retirement will be fully exempt. In other words, no amount for the value of leaves not enjoyed will be taxable, which greatly benefits in retirement situations.

Taxability for Private Sector Employees

For any employee working with a non-governmental organisation, tax exemption on leave encashment is charged differently. The tax exemption is calculated based on the least amount of any of these:

• Amount notified by the Government as to be 25,00,000
• Actual leave reimbursement
• Average salary for the previous 10 months
• Salary per day x Unutilized leave Whichever amount is the least, that is considered as the tax exemption amount.

Retirement vs. Resignation and Leave Encashment

There are two cases which are often confused; leave reimbursement during resignation and during retirement.

• At Retirement: Workers can encash their unused leaves, and the amount shall enjoy tax exemption for government workers. The ceilings apply in this case.
• At Resignation: An employee may encash his/her leaves upon resignation. The taxation treatment shall be the same as that of the other leave payout, that is, exemption ceilings would apply, and the excess amount over it would be taxable.

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Conclusion

Leave encashment is one of the rewarding benefits for an employee in India; it provides the means for an employee to be compensated in cash for the leave remaining unutilized. Familiarity with the leave encashment rules, exemptions, and calculation procedures with respect to leave reimbursement is important for both employees and employers. Besides rewarding financial relief to employees, it ensures good leave policy management by an organization. For more in-depth insights on employee benefits and taxation, you might look into a professional or your human resources increase department.