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HomePayroll and SalaryLeave Encashment Decoded: Understand the Norms and Calculate the Right Leaves

Leave Encashment Decoded: Understand the Norms and Calculate the Right Leaves

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Leave encashment is when employees can get cash benefits by selling their paid leaves. Employees collect unused leaves or vacation time, so they can be encashed when they retire or resign.
Employees encash unused leaves when they leave the organisation or their employment ends. Aside from that, employees can encash their vacation time instead of taking vacations for holidays to secure an amount for future needs. This encashed lump sum amount can be taxed. However, there are specific ways to get an exemption from it. 

Did You Know? Most organisations follow the 1948 Factories Act, according to which they must settle all unused leaves or even bonuses. 

What is Leave Encashment?

Different organisations have different rules associated with leave encashment. However, the employer, even the government, is entitled to pay a certain amount for the employee’s unused leaves. Some organisations either pay for the leaves taken or sum up the total number of unused leaves. They settle them according to current pay or shift them to the following calendar year.

Limit on Leave Encashment

The maximum limit of leave encashment for any employee is 300 days or 10 months of leaves for their entire work tenure or service days. The leave encashment is settled by adjusting it to the current salary with the basic pay and dearness allowance (DA).

When an employee resigns from an organisation, he/she can encash unused leaves. However, when they are removed from an organisation, their leave encashment is subject to the organisation’s policies mentioned in the employment contract. The organisation may or may not provide cash benefits for unused leave at termination and will only comply with basic labour laws.

In case of retirement, regardless of whether they are government or non-government employees. They are entitled to leave encashment, the total of all unused leaves adjusted to their current salary with earned and half-paid leaves in accumulation.

In the Union Budget, several measures were announced to offer relief to salaried individuals and the common man. Nirmala Sitharaman, the finance minister, proposed to raise the tax exemption for leave encashments on retirement from ₹3 lakhs to ₹25 lakhs.

Also Read: TDS on Salary | How is TDS calculated on Salary under Section 192

Types of Leaves

Government employees are fully exempt from tax on leave encashment.

1. Casual Leave

One of the most common leaves used by employees is casual leave. Depending on every organisation, an employee can take a week’s leave or, at most, 10 days a month. The employee must inform the company about the leave duration, when they’ll re-join, and whether they may get cash encashment.

2. Privilege Leave

As the name suggests, the employee can encash privilege leave after a certain period. Though different company policies vary, PLs are generally provided to employees with prior information.

3. Medical Leave

If an employee suffers from a particular health condition and cannot work for a certain period, they can encash their medical leaves with prior notification. The maximum number of medical leaves offered during a year may vary from company to company. 

If an organisation sanctions them, they are encashed. Moreover, long medical leaves are not granted by any company and may not get entitled to encashment.

4. Sabbaticals

These leaves are given to employees to expand their skills and knowledge, which benefits the organisation in the long run. In other words, these are paid leave days sanctioned for employees to improve their skills, such as completing an MBA, to add more value to the company.

5. Holiday Leaves

Holiday leaves are leaves employees encash for the holidays they get to celebrate, like, for instance, Independence Day.
6. Maternity Leave

These leaves apply to female workers who can take a leave of absence during pregnancy. Maternity leaves are paid during that period and may not include extended time after childbirth. Moreover, it may vary from company to company as some pay partial salary or even make it unpaid.  

Also Read: Standard Deduction for Salaried Individuals in 2023 | Income Tax

How is Leave Encashment Calculated?

Let’s understand the calculation of leave encashment with an example.

Example:

1. Leave Account

Earned Leaves due

250

Half pay leaves due

150

Maximum leave encashment allowed

300

Authorised EL for encashment

250

Authorised HPL for encashment

50

Total authorised leaves for encashment:

300
 

2. Last Salary Detail 

Last basic pay (BP)

 ₹ 53,000

DA 17%:

₹ 9,010

Total salary (BP and DA):

₹ 62,010

Half of the salary

 ₹ 35,510

Calculation of encashment of ELs

Authorised EL for encashment:

250

Total emoluments (BP and DA):

₹ 62,010

EL encashment: (total salary / 30) x number of ELs

                     = (62010 / 30) x 250

                     = ₹ 5,16,750

Calculation of encashment of HPL

Authorised HPL for encashment: 50

Half of the salary: ₹ 35,510

HPL encashment = (half of salary / 30) x number of HPL

                         = (35510 / 30) x 50

                       =  ₹ 59,184

Total encashment = EL encashment HPL encashment

                           = ₹ 5,75,934
 

Tax Treatment for Leave Encashment

Any employee, whether government or non-government, enjoys certain leaves like medical or privileged leaves. However, they can pay taxes on unused leaves when they encash them. However, this treatment may differ for government and non-government employees. 

It is common for employers to allow their employees to adjust their unused leaves in the next calendar year, which they might be able to use at a later date. Moreover, any amount received by encashing leaves when still in service is subject to taxation under the “income from salary” category. 

However, the government provides exemptions on the amount of leave encashment.  

  • Any government employee is not entitled to taxation on the amount encashed by selling their unused leave at retirement/resignation.
  • However, a non-government employee can only be exempt from tax under IT section 10(AA) (II) and pay the rest.
  • Only under specific conditions, when the legal heir of any deceased non-government employee receives any leave encashment, is the amount fully exempt from taxation.

Let us look at a real-life scenario to understand how the taxation on leave encashment is calculated.

For instance, Ram is a non-government employee with 15.1 years of service and now retiring.

Ram was entitled to 30 days of paid leave every year from his organisation. This amounted to about 450 days of leave for the 15 years of service he gave to his company.

Ram had already used 120 days of paid leave.

He is now left with just 330 days of unused leave.

Ram has a current salary of ₹ 43,500 per month at the time of his retirement.

He received ₹ 4,78,500 as leave encashment calculated based on 330 days X ₹ 1,450 (pay per day = 43,500/30 days).

Tax Exemptions for Leave Encashment

According to recent news, tax exemption for leave encashment at retirement is proposed to increase to 25 lakh rupees for non-government employees. Earlier, it was set to around ₹ 3,00,000

The maximum limit of leave encashment for any employee is 300 days or 10 months of leaves for their entire work tenure or service days. Additionally, employees get a cash benefit of 30 paid leaves for every year of service.

Leave encashment received

₹ 4,78,500 (330 days x ₹ 1,450)

Less exemption

 ₹ 2,75,000

Least of the following:

1. Amount the govt has authorised

2. Total leave encashment 

3. Last 10 months’ salary average  –      ₹43,500 x 10

4.  ₹ 1,450 x  (30 days x 15 service years – 120 days of leave used)

 

 ₹ 25,00,000

 ₹ 4,78,500

 

 ₹ 4,35,000

 

  ₹ 2,75,000

 Taxable Leave encashment 

  ₹ 2,03,500

Any amount employees receive upon resignation or termination is exempt from tax partially up to a certain extent. 

The amount received by encashing unused leaves at retirement is exempt from tax up to ₹25 lakhs of the total leave encashment amount. After deducting, any government employee has fully exempted from tax on leave encashment 25 lakhs; the remaining amount is taxable as income from salary. This extra amount will be taxed at the individual’s tax slab under income tax rules.

Also Read: Basic Salary – Basic Salary Calculation, Salary Deduction, Formulas

Leave Encashment Eligibility

  • Leave encashment eligibility refers to the criteria that an employee must meet to receive payment for unused leave days when they leave their job or retire.
  • The eligibility criteria for leave encashment may vary depending on the policies and regulations of the employer.
  • The excess leaves not used in a year are adjusted as paid leaves for the following calendar year. 

Conclusion
Knowing the different types of leaves is crucial for an employee to encash their leaves properly. With the exemption limit being pushed to  ₹25 lakhs rupees, non-government employees are relieved from taxation. Organisations have different definitions for the kind of leave and may deal with leave encashment in their own way. For non-government employees, section 10(AA) (II) will be exempted from the leave encashment.

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