Leave Encashment in India

The compensation offered to employees by their employer for unused paid leaves when they resign or retire is known as ‘leave encashment’. Under the labor laws, all salaried employees are qualified to take a minimum number of paid leaves every year. However, it is not mandatory for employees to utilize all their entitled leaves, and many employers offer the option to carry forward these unused leaves to subsequent years.

Employers must compensate employees for all their unused leaves; this is known as leave encashment. It is important to note that the rules and policies regarding leave encashment may vary from one company to another.

Types of Leaves

There are several different types of leaves, which can be found in the policy of a company. Different companies are bound to have different policies and, thus, different companies have different numbers and types of leaves. Some types of leaves usually mentioned in policies and available for the employees are:

• Casual leave: These leaves are the most common types of leaves used by employees. Although the permissible casual leave period varies in different companies, they generally range from 7 to 10 days. Policies related to casual leaves can be found with the employer. Employees are required to inform their employer about availing such leaves along with the duration and the date they will join back.
• Earned leave or Privilege: Earned leaves can be availed of after notifying the relevant authority in advance. You can encash such leaves after a specific period. It should be noted that the policy for such leaves and the period after which they can be encashed varies from company to company.
• Medical leaves: Medical leaves can be taken in case an employee faces some health issues. To avail of any unused medical leaves, the employee must inform the employer of the same, who shall, thereafter, sanction it. Once sanctioned, such leaves shall become eligible to be encashed. It must be noted that different companies allow different numbers of medical leaves to be encashed. As such, long periods of medical leaves might not be eligible for encashment in all organizations.
• Holiday leaves: All employees are granted certain holiday leaves, for which no salary is deducted. The number of holiday leaves vary in different organizations.
• Maternity leaves: Only female employees have the option to avail of maternity leaves and can do so for a period of 12 to 26-weeks during their pregnancy. If required, employees may ask for some more time to rest. However, the employer may not make any payments for the extended period.
• Quarantine Leave: If there is an infectious disease in the employee's family or surroundings, the employee can use quarantine leave. Allowing for rest may prevent other employees from being affected by the disease. This cannot be considered for leave encashment.
• Sabbaticals: Companies offer sabbaticals to employees planning to enhance their skill set and expertise by availing certain courses. Sabbaticals are paid leaves and are eligible for encashment as well.
• Paternity Leave: This leave is mainly intended for employees who become fathers. However, only government employees can avail paternity leave in India. A parent can get 15 days of leave before or after the birth of a child. Leave can be taken for a maximum of 6 months after the birth of the child. This cannot be considered for leave encashment.
• Half-pay Leave: Only government employees are entitled to this leave. After employees have worked for the organization for one year, they can take half-paid leave as needed. With this time off, the employee receives half a day's pay for the holiday. The inclusion of these during leave encashment depends upon the government organization.

The following leaves are eligible and non-eligible for Leave Encashment

S. No.	Type of Leave	Eligibility for Encashment
1	Casual Leave	Eligible
2	Privilege Leave	Eligibility varies
3	Medical Leave	Eligible (Excluding long-term)
4	Sabbaticals	Eligible
5	Holiday Leaves	Eligible
6	Maternity Leave	Not eligible
7	Quarantine Leave	Not eligible
8	Paternity Leave	Not eligible
9	Half-pay Leave	Eligibility varies

Taxation on Leave Encashment

Both private and government employees are eligible to apply for different types of leaves such as sick leave, casual leave, earned leave, and privileged leave during their period of employment. Although you can carry forward some of these leaves, you may not be able to do so with the others.

However, the total number of leaves availed and encashed is assessed by the organization, while the amount received is calculated by tax associations. Furthermore, the latter also reviews whether leaves are encashed during employment or when retiring.

Note: The taxation on leave encashment depends on whether the employee is a government or a non-government employee.

Leave Encashment received during Service

Leave encashment received by employees is subject to taxation depending upon when it was received. If an employee’s leave is encashed while on the job, the entire amount constitutes a part of ‘Income from Salary’ and is taxable. However, all employees can avail certain tax benefits under Section 89 of the Income Tax Act. Form 10E must be filled in to claim tax reliefs for leave encashment. This form can be filled in and submitted online on the Income Tax Portal.

Leaves Encashed when Resigning/Retiring

Following are the conditions under which employees can get their encashed leaves partially or completely exempted from taxability:

• State & Central Government Employees: All encashed leaves are entirely exempted from taxes.
• Non-Government Employees: All encashed leaves are partially exempted and partially taxable. Exemptions are based on the calculations stated in Section 10(10AA)(ii).
• Legal Heirs of Deceased Employees: Any amount received by a legal heir of a deceased employee is entirely exempted from taxation.

Latest Development

In line with the recent budget announcement, the tax exemption limit for leave encashment for employees at the time of retirement was raised from INR 3 lakhs to INR 25 lakhs for the salaried employees of the private sector. The increase in this amount aims to align such exemptions with the new income landscape. As per the Central Board of Direct Taxes (CBDT), the total amount exempted under Section 10(10AA)(ii) shall not be more than INR 25 lakhs when the amount is received from multiple employers; this was made applicable from 1 April 2023.

Employees must familiarize themselves with the rules and regulations as well as the limits related to leave encashment to ensure they make financially beneficial decisions. In addition, availing the expertise of a tax professional or referring to the latest changes made to the Income Tax Act can offer accurate information based on individual circumstances.

Checklist for Leave Encashment

• All salaried employees are allowed a minimum number of paid leaves every year.
• Employees are not mandated to use all the leaves they are granted in a year.
• Employees are generally permitted by companies to carry forward their leaves. However, this may vary in different organizations.
• This eventually leads to employees having several unused leaves when resigning or retiring from the organization.
• Companies are required to encash all the unused leaves of their employees.

Calculation for Leave Encashment

Following is the formula to compute leave encashment exemption for non-government employees:

*Proposed limit increase from INR 3 lakhs to INR 25 lakhs has been incorporated.

Particulars	Amount
Leave encashment received (A)	XXXX
Less: Exemption under Section 10(10AA) – (B) Least of the following:	XXXX
i) Amount notified by the Government** INR 25 lakhs (C) ii) Actual leave encashment amount (D) iii) Average salary* of last 10 months (E) iv) Per day salary * unused leaves (considering a total of 30 leaves/year) for every year of completed service (F)	25 lakhs XXXX XXXX XXXX
Leave encashment taxable – (A) – (B)	XXXX

*This salary includes the basic salary, dearness allowance & commissions depending upon the part of turnover obtained by the employee.
                        
**The overall amount that can be exempted is INR 25 lakhs, irrespective of how often the employee has encashed leaves with different employers. If an employee has encashed INR 5 lakhs from one employer at a time, they may only be eligible to encash INR 20 lakhs the next time. As such, you can see that the overall amount eligible for exemption is INR 25 lakhs from all employers.

Conclusion

Leave encashment offers employees the opportunity to receive compensation for their unutilized paid leaves. Although encashed leaves are eligible for taxation, there are different exemptions for government and non-government employees when retiring or resigning. Employees must stay up to date with the latest tax laws and consult professionals to ensure they comply with all relevant laws and maximize their economic gains.

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