Leave encashment in India - Meaning, calculation & tax rules

Leave encashment in India allows employees to receive monetary compensation for unused paid leave days. This benefit applies to both public and private sector employees, though policies may vary across organisations.

In the public sector, government employees often have standardised leave encashment policies with clear guidelines for compensation. In the private sector, companies establish their own leave encashment policies, which may differ in terms of eligibility and calculation methods. 

• What is Leave Encashment in Salary? 

Leave encashment in salary refers to the payment employees receive for their unused paid leave days. This amount is added to their salary income and is subject to taxation based on specific rules and exemptions.

Annual leave encashment enables employees to convert accumulated leave into cash. It offers financial benefits, especially upon retirement or resignation. Understanding the specifics of leave encashment policies is essential for employees to manage their leave effectively and plan their finances.

In India, the types of leave eligible for encashment vary by company policy and employment terms. 

 Types of Leave Eligible for Encashment

•  Earned Leave (EL) or Privilege Leave (PL) : Employees accrue these leaves over time and can encash them during service or upon resignation.
•  Annual Leave : Annual leave is similar to earned leave. It can be encashed depending on organisational policies.
•  Holiday Leave : Some companies allow encashment of unused paid holidays. However, this depends on the specific company rules and terms of employment.

 Types of Leave Ineligible for Encashment 

• Casual Leave : Casual leaves are generally intended for short-term personal needs and are usually not encashable.
•  Sick or Medical Leave : Sick or medical leave is aimed at health-related absences and is typically not eligible for encashment.
• Maternity and Paternity Leave: Maternity or paternity leave is provided for childbirth-related absences and generally is not encashable.

Please note that leave encashment policies can differ between organisations. As an employee, you should discuss your company's leave policy with the HR to understand the specific terms and conditions. This will help you understand the situation that applies to your specific cases.

Leave encashment in India refers to the payment employees receive for unused leave days. The tax treatment of this amount varies based on employment type and timing of encashment.

• Leave Encashment During Employment: If an employee encashes leave while still employed, the entire amount is added to their taxable income. And it is taxed as per their applicable income tax slab. However, under Section 89 of the Income Tax Act, employees can seek tax relief by submitting Form 10E.
• Leave Encashment At Retirement or Resignation:
  • Government Employees: Leave encashment received upon retirement or resignation is fully exempt from tax.
  • Non-Government Employees: The exemption is determined by Section 10(10AA)(ii) of the Income Tax Act. The least of the following amounts is exempt:
    • Actual leave encashment received.
    • ₹25,00,000 (as per the 2023 update).
    • The average salary of the last 10 months.
    • Cash equivalent of unutilised leave, considering a maximum of 30 days leave per year.
  • Any amount exceeding the exempted portion is taxable as salary income.
• Leave Encashment Upon Employee's Death: If leave encashment is received by the legal heir of a deceased employee, it is fully exempt from tax.

It is essential for employees to understand these tax rules for leave encashment. It will help you plan your finances effectively and minimise tax liabilities associated with leave encashment.

Also Read: Benefits of Workman Compensation for an Organisation

Leave encashment allows employees to receive monetary compensation for their unused paid leave days. If you are wondering, how is encashment of leave calculated, the calculation of leave encashment generally involves the employee's basic salary, dearness allowance (DA) and the number of eligible leave days.

• Leave Encashment Formula 
• Leave Encashment Amount = (Basic Salary + Dearness Allowance) / 30 × Number of Earned Leaves

Components Used to Calculate Leave Encashment 

• Basic Salary and DA: Basic salary and DA are the primary components considered in the calculation. Other allowances and benefits are usually excluded.
• Number of Days Eligible for Encashment: This depends on the organisation's leave policy and the total accumulated earned leave of the employee.

Leave encashment policies and tax exemptions for non-government employees can vary between organisations. Employees should consult their company's HR department and refer to the Income Tax Act provisions to understand the specific implications applicable to their situation.

• Please Note: For government employees, the entire leave encashment amount received at retirement is exempt from tax under Section 10(10AA)(i) of the Income Tax Act.

Factors Affecting Leave Encashment Exemption for Non-Government Employees 

• Salary Slab : The basic pay, dearness allowance and commission form part of the salary for calculation.
• Period of Service: The exemption considers the total tenure and average salary drawn during this period.
• Number of Unused Leaves : The calculation involves the unused leave balance, subject to company rules. 
• Government-Notified Limit : As of April 1, 2023, the maximum exemption limit is ₹25 lakh. This lifetime limit applies to all employers.

Leave encashment provides employees with the option to receive monetary compensation for their unused paid leave days. This option offers a lot of benefits to employees:

•  Financial Flexibility

Employees can convert unused leave into cash. It provides additional income during employment or at the time of their retirement.

• Tax Exemptions on Leave Encashment 

Leave encashment is also eligible for tax exemptions under certain conditions. So, it reduces the taxable income of the employee.

•  Enhanced Employee Satisfaction 

Offering leave encashment can boost employee morale and job satisfaction, as employees feel rewarded for their commitment.

• Encouragement of Attendance 

Knowing that unused leave can be encashed may motivate employees to maintain consistent attendance, which in return may boost workplace productivity.

•  Retirement Cushion 

At retirement, leave encashment provides a lump-sum payment. It aids in financial planning for post-retirement life.

These advantages make leave encashment a valuable component of employee compensation packages and benefits for both employees and employers.

Understanding leave encashment in India is vital for effective financial planning and tax management. It offers employees financial flexibility by converting unused leave into monetary benefits. However, relying solely on leave encashment may not suffice for unforeseen medical expenses.

This is where group health insurance becomes essential. While leave encashment provides a financial cushion, it does not specifically address healthcare costs. A comprehensive group mediclaim policy provides necessary medical care without financial strain. Combining leave encashment benefits with robust health coverage offers employees holistic financial security.

At TATA AIG, we understand the importance of safeguarding your employees' health. Our group health insurance plans offer comprehensive coverage, such as inpatient and outpatient treatments, maternity benefits and more. With an extensive network of hospitals and a hassle-free claims process, we ensure your team receives timely medical attention. 

Investing in our group mediclaim policy enhances employee satisfaction. It also boosts productivity by reducing health-related absences. Prioritising employee well-being through comprehensive business insurance reflects a company's commitment to its workforce. 

Choose TATA AIG's business insurance to provide your employees with the healthcare support they deserve. Secure your business's future by investing in the health and happiness of your team.

Also Read: Benefits of Group Health Insurance Policy for Employees

 How do I check my leave encashment in India? 

To check your leave encashment eligibility and balance, access your company's HR portal or payroll system. You may also consult your HR department for personalised assistance.

Can leave encashment be availed during employment, or is it only upon retirement or resignation?

Yes, employees can avail of leave encashment during their employment, depending on the company's leave encashment policy. Encashment during service is taxable with certain exemptions that may apply upon retirement or resignation. 

Is leave encashment mandatory for employers to provide, or is it discretionary? 

Even though the labour laws mandate provides earned leave and offers leave encashment, it is not universally compulsory. It depends on company policies and employment contracts, especially in the private sector. 

 How is leave encashment calculated for employees with variable dearness allowance (DA)?

For employees with variable DA, leave encashment is calculated based on the average DA over a specified period, mostly the last ten months, along with the basic salary. This ensures a fair computation reflecting salary fluctuations.