The process of Leave Encashment

Salaried employees working in government and private sector, however, get nearly equal work benefits regarding their pay scale, tax deductions and leaves. The employee is subjected to pay income tax if their annual income exceeds the limit as advised by the income tax department. The employer deducts some amount from the employee’s salary account and deposits that amount in the provident fund (PF) account. The provident funds are accessible for the employee throughout their employment period and after retirement. The employer also offers incentives and allowances like travel, food, accommodation for the employee during their employment period. There are insurance policies provided by the organization for the employees through which they can claim them during health emergencies and use the matured amount after retirement. However, an employee can carry forward their leaves if not used in the year and can later ask for encashment on behalf of the leaves untaken. This process is known as leave encashment and every employee can get its benefits.


What is Leave Encashment?

Leave encashment is a leave carry forward process provided by the organization to the employee and it can be availed on unused leaves of the employee.As these leaves get credited every year, the employee can ask for encashment at the time of their resignation from the company or after retirement. The organization keeps data of the used and unused paid leave by the employee and balances at the end of the employment period. The employee can receive a day’s salary for every paid leave day in the encashment process. This process is valid for every employee working in the organization. Before that, let's get to know about the types of leaves employees can get and its benefits for further leave encashment.


Types of Leaves and Leave Encashment

Employers also provide various types of leaves other than holidays for the employees. In order to have a good balance between work and personal life the organization offers multiple leaves for their employees during their work tenure. Besides, the leaves provided are categorized as paid and unpaid leaves. The types of employment leaves are:

Types of Leaves Description
1. Casual Leave This type of leave is most commonly availed by the employee. This leave can be taken for a maximum of seven days. However, it depends on the guidelines provided by the employer for each organization may vary. The employee has to inform the employer about the casual leave to be taken beforehand and mention the number of days or duration of the leave. It will be considered for leave encashment if it is allowed to be carry forward as per company’s policy.
2. Privilege Leave The employee can get this leave by providing prior information about the leave towards the employer. The leave is paid and is sanctioned by the employer. If this leave is not availed by the employee they can further accumulate them and encash them later. However, each organization has its own set of regulations regarding privilege leave and its encashment.
3. Medical Leave The employee can avail this leave if they are ill and are not be able to work in normal conditions. They have to inform to the employer for availing the leave. The number of medical leaves granted to the employee depends on each organization and such leaves are paid leaves. As this leave is a kind of emergency leave, no prior information is mandatory before the leave from employee to the employer. Whereas the employee has to provide a valid medical certificate to the employer if leave is taken for a longer period of time. This cannot be considered for leave encashment.
4. Maternity Leave It is provided to female employees who are pregnant during their employment period. The leave is paid for the period from 12 weeks up to 26 weeks of pregnancy. More extension period is also given by the employer until the next 16 months but that leave period is unpaid. During the leave period, deductions are not made from the leave salary account. This cannot be considered for leave encashment
5. Quarantine Leave If there is an outcome of any infectious disease in the family or in the neighbourhood of any employee, the employee can avail of quarantine leave. Granting this leave can prevent other employees from getting infected from the disease. This cannot be considered for leave encashment.
6. Sabbatical Leave This leave is granted for the employees willing to expand their knowledge by adopting for various relevant institutional courses. They can adopt for any specialized training or workshop which is relevant to their working field and can also take admissions to universities for long term courses. These leaves are paid for a period of time as decided by the organization. This cannot be considered for leave encashment.
7. Paternity Leave This leave is especially available for the employees who become fathers. However, only government employees may avail the benefits of paternal leave in India. The parent employee can be granted 15 days of leave before or after the birth of a child. The leave can also be availed up to 6 months from the child’s birth.This cannot be considered for leave encashment.
8. Holidays Holiday leaves are paid leaves and there is no deduction from the salary account of the employees. Holidays include national holidays, festivals and weekly off. Employees working in all sectors enjoy these holiday leaves. This are considered for leave encashment.
9. Half pay Leave This leave can be availed only by the employees working in government organizations. Once the employee completes their one year in the organization they can avail half pay leaves as and when required. In this leave, the employee receives half day salary during their leave period. The inclusion of these during leave encashment depends upon the  govt.organisation 

Providing such leaves has multiple benefits for employees as well as for the organization. In case of any medical emergency or health conditions employees can avail medical leaves which are extendable. Maternity and paternity leaves are very important and useful working women during their pregnancy. Holidays are the perfect leaves where employees can enjoy festivals and their time with their loved ones. Availing sabbatical or study leaves can really help employees to advance their knowledge levels and skills further adding more flexibility and confidence while working. Organizations get a lot of benefit from the study leaves as employees trained with new skills and knowledge add more to the organization thus improving business. Paid leave granted by the organization lets employees balance their work-life and creates a sense of trust while working with the organization. Perhaps organizations have to take care of their employees in all conditions and employees should in return the generosity by giving their best working performance.

Labour Act : A Guideline for Employers and Employees

Every organization provides working guidelines to its employees based on the regulations of labour law. The labour law lays regulations regarding the terms and conditions of employment, discrimination, employment leave rights, employee representation and employee privacy rights. All organizations working in India should comply with these regulations and provide guidelines to their employees. The regulations set by the Labour Act ease the recruitment process of an employee, their agreements with the organization, basic pay scale provided as per minimum wages and other employee protection guidelines. Rights regarding leaves for the employee taken during the employment duration should comply with the Labour Act. Therefore organizations should always follow regulations provided in order to secure employee rights.


Leave Encashment and Tax

During employment period

Any employee demanding leave encashment for their unused paid leave during their employment period is taxable as it is considered as income from salary. In this case, the employee can get tax relief under Section 89. As per Section 89, the employee can claim tax relief from the amount received through the leave encashment process. In order to get tax relief for leave encashment, the employee should file form 10E. This form is easily available on the e-portal of the income tax department and once filled can be submitted online. The only tax is paid during the encashment will be income tax from salary.

After retirement or resignation

At the time of retirement or resignation, the employee can avail encashment through their accumulated paid leave. However, there are various conditions depending upon the type of organization in which the employee has worked.

  • When the employee has worked in the central or state government organization, they can fully claim for their paid leave encashment and that too with full exemption from tax.
  • In the case of employee’s death before the leave encashment, their legal heirs can receive total leave encashment on behalf of the deceased. No income tax will be charged on the amount received by them.

Employees working in the private sector can receive paid leave encashment at the time of retirement or resignation.Maximum tax exemption amount is Rs 3, 00,000 for the leave encashment otherwise amount exceeding this value is taxable. The calculation of exempt leave encashment os as per section 10(10AA)


Tax Exemption Under Section 10(10AA)

In such a case, the following points are considered in order to receive the exemption under section 10(10AA).

  • The leave encashment amount actually received is taken into account
  • The average salary of 10 months. The salary includes basic salary and dearness allowances. Also, the commission received is considered. The salary of 10 months actually considered is on the basis of salary received during the 10 months preceding their retirement or resignation.
  • Even if the employee has accumulated number of leaves in a year, the organization will consider only a maximum of 30 days of leave a year for the encashment process. According to it, the total number of paid leaves will be calculated altogether during the retirement or resignation and then encashment will be processed further. Suppose a person has not utilized all the paid leaves and it accounts for 45 days still the organization will only consider 30 days of paid leave for encashment at the time of resignation or retirement.
  • In the case of leave encashment during the employment period the amount received will totally be taxable in all forms. But according to Section 89, Income Tax Act, the employee can claim for tax relief from their leave encashment amount.
  • For employees who have retired after 1998, their leave encashment amount is subjected to a maximum limit of Rs. 3, 00,000 to be received which is specified by the government. When the actual amount to be received will be more than Rs. 3, 00,000, then 3, 00,000 will be received as the encashment amount and the remaining amount will be received in the salary account which will be taxable. This case applies only for non-government employees.
  • The legal heirs of deceased employees at the time of leave encashment can receive the amount without any form of tax deduction from the amount.
  • In case of resignation or termination, both government and non-government employees are held to pay the tax on the amount received from paid leave encashment because the amount at the time is considered as income from salary by the income tax department. The rate of tax to be paid is applied same as during income tax on salary.

To make it easy to understand, here is an illustration:

Mohan has retired from the organisation after serving for a period of 20 years. He was entitled to 32 days of paid leave in a year.But he exhausted leave 275 and left with 365 days of leave.He draws basic salary +D.A INR 30000 per month at the time of retirement. He received leave encashment of INR 365000 (365*1000).

Taxable leave encashment will be:
Actual amount received : INR 365000
Average Salary of 10 months: 300000
(30*20-actual leave taken)*1000 = 325000
Maximum Allowed: 300000
Lower of all is exempt i.e. INR 300000
Therefore, taxable leave encashment will be 65000(365000-300000)


Conclusion

Hence, leave encashment process is totally transparent and easy to avail by employees during or after their employment period. The government of India has provided the Labour Act according to which the employees should get equal rights, leaves and wages. The leave encashment policy works the same for every employee. This encashment amount can further be useful for important things like healthcare, education of their children and personal savings. Considering the cost of inflation the leave encashment can be received during the employment period or after retirement. The employee can decide whether to receive a one-time amount or in stages. When the amount is large, employees should plan their tax returns accordingly.


Frequently Asked Questions

Q- How leave encashment is calculated?

Ans: Leave encashment received by govt employees are tax free. leave encashment received by private employees are minimum of the following:
1. Amount received as leave encashment
2. Maximum amount stated by government i.e. 300000
3. last 10 months of basic salary and DA
4. Salary per day*unutilised leave (consider maximum 30 days leave per year) for every year of completed service


Q- Can Leave encashment be withheld?

Ans. Leave encashment can be withheld if assessee faces a criminal cases or any departmental proceedings at the time of retirement.


Q- Is leave encashment taxable on resignation?

Ans. Leave encashment is taxable whether it is received on retirement or resignation for private employees.


Q- What is leave encashment?

Ans: Leave encashment refers to the monetization of unavailed leave which is carried forward.


Q- What is provision for leave encashment?

Ans: The provision of leave encashment is that maximum of INR 3 lakh is exempt from and for govt employee it is fully tax free.


Q- How many leaves can be encashed?

Ans. Leaves earned by the employees can be encashed in the next year, the quantum of leaves encashed is not more than 50% of earned leaves at credit or 30 days earned leave whichever is less.


Q- Can casual leave be encashed?

Ans. It depends upon the policy of your company. If CL is paid to a certain days then it can be encashed.


Q- Is leave encashment taxable for bank employees?

Ans. Yes leave encashment is taxable for the bank employees subject to certain conditions


Q- Is leave encashment a perquisite?

Ans. The number of leaves an employee can avail and the leave encashment allowed are dependent on the employer. The amount received as leave encashment is a perquisite to the employee and the tax implications are dependent on whether the leaves are encashed during the course of employment or at the time of retirement.


Q- How does gratuity benefit works for the employees?

Ans. Gratuity is a benefit given by the employer to employees. As per recent amendment,tax exempt up to Rs 20 lakh from the previous ceiling of Rs 10 lakh, which comes Section 10(10) of the Income Tax Act.


Q- Is leave encashment taxable on resignation?

Ans. Leave encashment is taxable on resignation for a non-government employee based on calculation as per section 10(10AA).For a government employee, leave encashment received after retirement or resignation is exempt from tax.


Q- What is leave encashment formula?

Ans. Leave encashment for non-government employee can be calculated as :

  • Actual amount received.
  • Average Salary of 10 months
  • 3,00,000 Whichever is lower is exempt.

CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.