All about Leave Encashment and its tax implications
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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?

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.

Types of leaves encashment 

  • Sabbaticals leave –

This leave is provided to the employee by the employer to expand and upskill their knowledge. An organisation reimburses them to upskill, and it is considered paid leave. But, it differs for organisations.

  • Holiday (Restricted or Gazetted Holiday) –

Holiday leave applies to paid leave. Under this leave, your salary will not be deducted by the employer.

  • Medical leave – 

If an employee’s health conditions are not good and he/she is not able to work, then they can avail of medical leave. But, they have to inform the employer about the leaves. Once the employer sanctions leave, then leave can be availed.

  • Casual leave –

Usually, casual leave is allowed based on organisation leave policy. Before applying for leaves, you need to inform your employer about your CL with the return date and time durations.

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.

Particulars

Amount (Rs.)

Received Encashment (A)

Tax Exemption – (B)

  1. Actual leave encashment 
  2. Notified amount 
  3. 10 Months avg salary
  4. One day of salary, ((30 days salary*completed year of service) – utilised leave pay),(((30*1500)*15)-(1500*150))

Exemptions , Least of (B)

So, taxable leave encashment 

3,37,500

3,37,500

3,00,000

  45,000

4,50,000

45,000

2,92,500

Related:

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9 Comments

  • Hi my friend! I want to say that this article is awesome, great written and include approximately all important infos. I would like to see extra posts like this.

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    • Thank you for reading and commenting. We are glad this blog was useful to you.

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    • Thank you for reading and commenting. We are glad this blog was useful to you.

  • i have received leave encashment on supernation. Please guide to what extent it is tax free, Aa my institution has deducted tax @20% beyond 3 lac,

    • Leave encashment on Supernation is fully exempt if your are a Central/State government employee. For others, its exempt till 3 Lac. Tax rate will depend upon your income slab. In case of PAN is not submitted, 20% may be deducted.

  • I got an amount of rs. 65000/- on my final settlement.
    When issuing the form 16 it’s shown in Taxable income.
    I asked them to update as Non taxable income under section 10(10AA) but company person has saying…
    if you not working anymore then only it will shown under 10( 10AA) othewise it is taxble income.
    Pls suggest can I file any case on the company for not updated in the non taxable income.
    how can i get my money back

    • Hi Nagaraju,

      Firstly, FFS is taxable. Secondly, your company person has rightly as income under 10(10AA) is exempt only on retirement or superannuation. So, the amount received by you will be taxable. If any amount is extra deducted, please file your income tax return and claim for refund