Leave Encashment

Definition

Leave encashment refers to the practice where employees receive monetary compensation for their unused paid leaves.

It provides a financial benefit, especially during retirement, resignation, or when leaving the organisation.

Employees can encash their earned leave instead of carrying it forward to the next year.

Types of Leave Eligible for Encashment

   
• Earned/Privilege Leave: Employees are entitled to encash a portion of their earned leaves, subject to company policy. Typically, up to 50% of accumulated earned leave can be encashed.
   
• Other Leave Types: Leaves such as sick leave, casual leave, and maternity leave are not usually eligible for encashment.

Eligibility for Leave Encashment

   
• Employees can opt for leave encashment upon retirement, resignation, or in certain cases, while still in service.
   
• The policy may vary across companies, but most organisations in India allow the encashment of earned or privilege leave.

Taxation on Leave Encashment

   
• During Service: Leave encashment while in service is taxable and added to the employee’s income under ‘Income from Salary.’
   
• At Retirement or Resignation:
         
  • Government Employees: The entire encashment amount is exempt from tax.
         
  • Non-Government Employees: Tax exemption is available up to ₹25 lakh, effective from April 2023, under Section 10(10AA) of the Income Tax Act. Any amount beyond this limit is taxable.
     
   

Leave Encashment Calculation

The formula for calculating leave encashment typically involves:

   
• Average Basic Salary: The average monthly basic salary.
   
• Average Dearness Allowance: The average dearness allowance received.
   
• Earned Leave Days: The total number of unused earned leave days eligible for encashment.

Exemptions and Benefits

   
• Legal Heirs: In case of an employee’s demise, the leave encashment amount is fully exempt from taxation and payable to their legal heirs or nominees.
   
• Government Employees: Encashment at retirement is entirely tax-free for government employees.
   
• Private Sector Employees: Encashment beyond ₹25 lakh will be taxable under specific conditions.

Key Points to Remember

   
• Leave encashment is generally viewed as a financial benefit, especially for long-serving employees.
   
• Organisations must clearly define their leave encashment policies, specifying which leaves can be encashed, the eligibility criteria, and the calculation method.
   
• Employees should be mindful of tax implications and plan accordingly to optimise the financial benefits of leave encashment.
   
• Encouraging employees to take time off ensures well-being and productivity, and leave encashment policies offer a financial cushion, especially during crucial life events such as retirement.

Frequently Asked Questions (FAQ)

Q. Can leave encashment be availed in partial amounts, or does it need to be taken in full?

A. Leave encashment policies depend on the organisation. Some allow partial encashment, while others may require the full amount to be taken at once. It's best to check with your employer for specific guidelines.

Q. Are there any limits on how many years of earned leave can be accumulated for encashment?

A. Many companies set a cap on how much earned leave can be accumulated. Typically, you can carry forward leaves for a limited period, and beyond that, they may lapse or become eligible for encashment.

Q. How do company-specific leave encashment policies differ between industries or sectors?

A. Leave encashment policies vary by industry and sector. For example, government employees enjoy full tax exemption, while private sector employees have limits on tax-free encashment amounts. Therefore, it's important to review your company's policy for details.