All about Leave Encashment and its tax implications

In this post, we will discuss briefly on leave encashment, events under which you can encash leaves, and tax computation.

We will cover the following:

• What is leave encashment?
• Types of leave encashment
• When can an employee avail encashment of leave?
• Calculation
• Tax implication on leave encashment

What is leave encashment?

During an employees’ service term, he / she is alloted various leaves like earned leave, casual leave, gazetted leave, etc. There are some leaves which an employee can carry forward to the succeeding year. Also, some leaves cannot be carried forward for the next year like casual leave, compensatory leave, etc.

In case an employee does not avail the leaves allowed to him, he can encash these leaves and earn an income for the said number of days. This policy of the number of leaves allowed to be taken and leave encash varies from employer to employer.

When can an employee avail leave encashment?

• During the tenure of the service
• At the time of retirement
• Termination of the service

Leave encashment calculation

There is no fixed rule as to how many leaves you can carry forward and how many leaves you can encash. Every company has its own rules. Here are some options used for leave encashment calculation:

• A percentage of Basic+Dearness allowance (DA) can be considered for calculation. For example, 10% of Basic + DA.
• Per-day salary can be considered. Here also we can consider all components or only Basic+DA.
• A fixed-rate can also be taken for encashment.

Tax Implication on Leave encashment

The taxability depends on if you are a government employee or a non-government employee.

 During the tenure of the service

Leave Encashment during the tenure of the service is fully taxable in all cases, relief u/s 89, if applicable, may be claimed during the income tax return.

At the time of retirement

Government employee:  Encashment of unutilized earned leaves at the time of retirement is fully exempted from taxability.

Non-government employees: In case of non-govt employees the exemption is to be limited to the least of the following:

1. Amount received as leave encashment
2. The amount stated by the government i.e., Rs 3 Lakhs**
3. 10 months average salary* before as on the last month of retirement
4. Cash equivalent of Leave encashed, subject to a maximum of 30 days for each completed year of service reduced by unutilised leave over the employment period

Salary here includes basic salary, dearness allowance and commission based on fixed percentage of turnover secured by employee

** Rs 3,00,000 is the aggregate amount allowed as exemption irrespective of leave encashment received by employees from different employers. If an employee has utilised Rs 2,00,000 already at the time of first resignation, he is only entitled to use the balance of Rs 1,00,000 for the exemption computation with the next employer. Hence, overall an employee is allowed a total exemption of only Rs 3,00,000 with respect to leave encashed from all employers.

For Example: 

Mr Arnav is going to retire after 15 years of service. He was receiving a salary of Rs 45000 as of the last month of employment and was entitled for 25 days of paid leave per year from the company. The leave balance at the time of his retirement was 225. As per the company policy, leave encashment is calculated based on the number of remaining (unutilised) leave multiplied by per day of salary.

Solution:

•  Mr Arnav per day of salary = 45,000/30

                               = 1,500

• Hence, Leave encashment received = 225*1500

= 3,37,500

• Total years served is 15 yrs with 25 leaves per year. I.e. 15*25 = 375 leaves in total. Total utilised leaves = 375 – 225 = 150

I.e. Mr.Arnav will receive an amount of Rs. 3,37,500 as leave encashment.

FAQs

• Are leave encashment and leave salary the same?

Yes, leave salary is a part of leave encashment which is acquired over time and encashed later.

• Is casual leave (CL) eligible for encashment? 

It depends on the organisation’s policy because it varies from one organisation to another. But in most cases, no. Only EL is eligible for encashment.

• Is it possible to withhold leave encashment?

Yes, it is possible to withhold leave encashment in case of criminal cases during their retirement or facing any department issues or proceedings.

• What is the maximum limit of leave encashment?

Maximum limit of leave encashment is 480 days that employees can take during their service.  But it can also be defined based on company policy.

Related:

• Income Tax Act – Meaning, taxability, slab, and calculation
• Maternity benefit act – Meaning, Applicability & Benefits
• Payment of bonus act applicability and calculations

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