Employers pay employees for unused leaves through leave encashment.
What is the exact calculation for encashing leaves? What is the tax treatment of leave encashment? How long do leaves have to be encashed before they can be cashed?
All of these questions are answered in this blog post. Learn more about it by reading on.
What is leave encashment?
Employees’ dues for services rendered are cleared by the employer via cash or adjusted for the next calendar year’s leave quota according to this policy.
Encashment means the employee is able to use this leave balance upon retirement, leaving the company, or continuing to work for the organization. When an employee resigns or is terminated, the company includes their leave encashment in the full and final settlement.
Various companies have different leave encashment policies, and the rules are different as well. In some companies, leave taken is usually paid for, or it is adjusted the following calendar year. The 1948 Factories Act stipulates that unclaimed leaves and bonuses must be settled within seven to ten days of resignation.
Types of leaves
It is important to know what types of leaves can be encashed in order to encash them. Leaves can be classified into the following types:
Casual Leave
Employees use it most frequently. Companies usually allow at least 7 to 10 days, but it varies from company to company. The organization has a specific casual leave policy, and the employee must notify the employer of his or her casual leave, the duration, and the date of his or her return. Cash encashment will be available if this request is accepted.
Privilege Leave
Prior information about the privilege leave must be provided to the employee, and the leave must be sanctioned. Various organisations have different policies regarding the encashment of privilege leaves after a certain period.
Medical Leave
Medical leave is available to employees who are unable to work due to their health conditions. As a result, pending leaves must be reported to the employer. Encashment of these leaves becomes possible once they are sanctioned. Each organization allows a different number of leaves. There is, however, an exception to the cash leave encashment window for long term medical leaves.
Sabbaticals
Upskilling and expanding knowledge are other types of leave that employers offer to their employees. There are several courses that can be taken to accomplish these goals. Paid leaves are reimbursed by an organization, and they can be encashed.
Holiday Leaves
A person’s salary is not cut as a result of holiday leaves. Encashment of these leaves is also possible.
Maternity Leave
Every pregnant female employee has the right to take maternity leave during the course of her employment. From 12 to 26 weeks of pregnancy is considered to be the period of gestation. Extending this period does not incur any payment. Organizations also have different maternity leave policies. Encashment is not possible for these.
Is leave encashment taxable?
When a person resigns or retires, any leave can be encashed. As part of the income from salary, it is fully taxable if encashed during service. Income Tax Act Section 89 provides some relief, however.
Conditions of exemption
Certain partial and complete exemptions are available when one encashes a leave at retirement or resignation. Exemption is subject to the following conditions:
- The encashment of leave is tax-free for employees of the Central Government or the State Government.
- Employees whose encashment is received by their legal heirs are fully exempt from encashment taxes.
- Government employees are exempt from leave encashment if they compute taxable income from their salary in accordance with Section 10 (10AA) ii.
Leave encashment calculation
how to calculate leave encashment – Here is an example of how to calculate leave encashment:
Having worked for 20 years, Mrs. Shanaya is retiring. As a result of her employment with the company, she was entitled to 25 days of paid leave per year. She had 500 days of leave during her career with the company.
The 150 days of paid leave she has already used of this have already been utilized by Mrs Shanaya. Her unutilised leave balance is 350 days.
As for her salary, she currently draws Rs 35,000 per month as a basic salary plus dearness allowance (DA).
The number of unutilised leaves multiplied by the salary per day is used to calculate leave encashment, which is as follows:
A daily salary of 35,000 divided by 30 equals approximately Rs. 1167 (approximately)
Leave encashment received = 350*1167 = 4,08,450
The leave encashment to Mrs Shanaya was therefore Rs 4,08,450.
| 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 |
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A company’s leave encashment calculations become more complex the longer an employee works there.
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