How much of encashed earned leaves in taxable? This article answers the question by giving an overview of leaves to employee, What is Earned leave, What is encashment of earned leaves? Is leave encashment taxable? What is the tax exemption limit on Leave Encashment? What are the tax implications of Leave Encashment? What are the rules on leave encashment for Government & non-government (Private) employees? How leave encashment is calculated the formula?
Table of Contents
Overview of Leaves For Employees in India
Leave is granted to employees with the good intention of providing rest, recuperation of health and for fulfilling social obligations. This provides for a healthy and efficient staff for the company. An employee is entitled to a certain number of leaves per year aside from the holidays and days off. An employee is allowed different types of leaves like Medical Leave, Gazetted Holidays, Casual Leaves Employees, across all industries in India. The number and type of leave depends on the industry,employer and state you are in under the Factories Act and State’s shop and establishment act. Overview of leaves in India are given below. Our article Casual Leave, Earned Leave, Sick Leave : Leaves in India covers it in detail.
- Leave is not a matter of right. Just because you have asked for leaves does not mean you will get it. Sanctioning of leave is at Management discretion based on exigencies of business or seriousness of the case. Employee need to apply for each leave and take approval except in cases where approval could not be taken in advance. Employer can refuse the leave application, if not satisfied with the reason of leave.
- Leave are calculated from 1st January to 31st of every year
- The different types of leaves are:
- Casual Leave (CL) : Casual leave is provided to to take care of urgent and unseen matters like you get call from school when your child falls down and you have to leave office.
- Sick Leave (SL) or Medical Leave : is provided when employee gets sick.
- Privilege leave or Earned Leave is provided for planned long leaves for the purpose of travel, vacation etc.
- Maternity Leave (ML) : Female employees are entitled to a maximum of 12 weeks (84 days) paid maternity leave.
- Paternity Leave: Paternity leave is paid or unpaid leave given to a male employee when a child is born.
- Loss Of Pay (LOP) : If person does not have any unused leave and the situation requires him to take the leave, then employer can allow him/her to take leave which can be adjusted against the future leave or no pay would be given for the leave.
- One should not club Casual leave with any other leave. But Sick Leave and Privilege leave can be clubbed together.
- Employees who are appointed during the course of the year are entitled to the above leaves on proportionate basis or pro-rate basis. For example if one joins in July one will one get half number of leaves.
- Employees whose date of joining service falls between 1st to the 15th of a month are entitled to get the leave credit for that month.
- Employees whose date of joining service falls between 16th to the end of the month are not entitled for the leave credit for that month.
- If an employee is relieved on any day between 1st to 15th of a month, then he / she is not entitled for leaves due for that month.
- If an employee happens to leave on any day between 16th to the end of the month then he / she is entitled for leaves due for that month.
Encashing Earned Leaves or Privilege Leaves
Earned leave is provided for planned long leaves for the purpose of travel, vacation etc. If one does not use all the Earned Leaves one can carry forward the leaves upto some limit defined by your company. On leaving the company, due to resignation or retirement one can get payment for unused Earned leaved. How can one encash the privileged leaves? Is encashment of privileged leave taxable or is some amount exempted? If yes what is tax exemption on unused leave.
What is Earned Leave?
- Earned leave is provided for planned long leaves for the purpose of travel, vacation etc
- Earned Leave is calculated on a month on month basis for the calendar year.
- Earned Leave is credited in the beginning of Calender Year to every employee’s account, but the entitlement will be proportional to the number of months worked. For example Based on company policy, for every month completed in the company 1.25 days will be credited to the employee’s entitlement.
- If you are unable to use all of your accrued Earned Leave during a calendar year, you may elect to carry forward any accrued but unused Earned leave into the next calendar year, subject to the maximum accrual level. Maximum number of earned leaves is based on the State in India(ex Punjab, Karnataka) your company is, which typically is 30 working days but in some states can go upto 45 or 60 days.
- Earned Leave accumulated can either be taken in the subsequent months or encashed as per the rules of the company.
- Accumulated leaves can be encashed at time of working or leaving the company based on company’s policy.
Can one encash any other type of leave?
No only Earned Leaves can be encashed. AIf an employee on leaving the company due to any reason, resignation or retirement, has availed more number of Casual Leaves or CL against the number of months he has worked, then the pay for excess CL may be deducted during his final settlement.
Is there difference between Earned Leave(EL) and Privileged Leave(PL)?
Terms Earned Leave(EL) and Privileged Leaves(PL) are used for same kind of leave. Although the nature and purpose of both PL and EL are same, however, applicability differs in terms of minimum allotment. Under Factories Act, 1 EL for every 20 days of work (18 per year)and on the other hand under Shop &Establishment Act 5 PL for every 4 months work (15 per year). So which term is used depend on the Act your company follows.
What is Encashment of Earned Leave?
If one has Earned Leaves and doesn’t want to use them then one can get money for unused Earned Leaves, upto the maximum limit set by your company. Getting paid for Earned leaves is called Encashment of Earned Leave. One can encash Earned Leaves while working or while leaving the organization. Employee may be leaving the company due to join another company or on retirement. If an employee is leaving the company and has Earned leaves which he has not used then the employer will pay him for the Earned leaves during the final settlement.
Does one have to pay tax on encashing the Earned Leaves?
Benjamin Franklin said there are only two things certain in life: death and taxes. So the amount one gets for encashing the salary may be Taxed. The taxation of Leave salary depends on
- Type of employee, Government or non Government
- Leave encashment is while working, or leaving job or retirement
On retirement tax on leave depends on whether. The retirement of employee may be of various kinds. It may be on superannuation or voluntary such as resignation. This section applies equally to a case of voluntary retirement on account of resignation.
- You are a government employee or not.
- A Non Government employee can claim Exemption under Section 10(10AA) if one has encashed leave on retirement . The maximum limit of exempted amount is Rs. 3 Lakh during the entire working life time.
How to calculate Cash Equivalent of Earned Leaves?
Cash equivalent of leave at the time of retirement or resignation = { ( ( ( Number of Years * Number of Earned leaves per year) – Availed Earned Leaves ) / 30) * Avg Salary }
- Number of years means completed years of service. If one has worked for 20 years 7 months, only 20 years will be considered.
- Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of completed service. If company provides more Earned leaves per year than 30 ex 40 number of Earned leaves provided is taken as 30 not 40. If, however, earned leave is credited at the rate of say 25 days leave for each year of service, calculation shall be made at the rate of 25 days leave for each year of service.
- 10 months Average Salary. Average Salary is to be computed on the basis of the average salary drawn by the employee during the period of 10 months immediately preceding his retirement.
- Salary for the purpose of above computation means Basic + Dearness Allowance . It also includes commission based on fixed percentage of turnover achieved by the employee. However, any other allowance received is not to be included in the computation of Salary.
Tax on Encashing Earned Leaves
As mentioned earlier in article
- If you encash your leaves, whether it is taxed or not depends on when you have encashed the leave, while in work or on leaving the company.
- On leaving the company tax on encashing earned leave depends on whether you are a government employee or not.
- One can claim Exemption under Section 10(10AA) if one has encashed leave on leaving the company . Extent of exemption depends on whether one is a Government or a Non Government employee. For a non Government employee maximum limit of exemption is 3 lakh applicable from Apr 1 1998.
- The Non exampt amount received for encashing leave would be taxed under head Income from Salary and would be Amount Charged to Tax = Amount received as Leave Encashment – Amount exempted
- Details of your Leave Encashment would be in Final settlement document / Salary Certificate / Form 16. Under Section 17 (1) you can find ‘LC’ amount and details regarding the Leave Encashment exemption can be found under section 10 (10 AAA)
Taxation of Leave salary for various categories of employees is shown in table below
| Status of Employee | Nature of Leave Encashment | Taxability |
| Government/ Non-Government employee | Leave encashment during Continuity of employment | It is chargeable to tax. However relief can be taken under section 89 |
| Government/ Non-Government employee | Leave encashment of termination of employee. | it is fully taxable |
| Government employee | Leave encashment at the time of retirement / leaving job | It is fully exempt from tax under section 10(10AA)(i) |
| Non-Government employee | Leave encashment at the time of retirement / leaving job | It is fully or partially exempt from tax in some cases under section 10(10AA)(ii) |
What is Tax on Leave Encashment while in Service?
For both Government and Non Government employee encashment of leave while in service is fully taxable and no exemption is allowed.
What is Tax on Leave encashment after the death of employee?
Leave encashment received by the family members after the death of an employee is not chargeable to tax in the hands of the family member.
What is Tax on Leave Encashment in leaving the job for Government Employee?
No tax would be levied on any amount received as leave encashment by govt employees on leaving the job or retirement. Entire amount is exempted under the section 10(AA)i.
What is the exemption on Encashment of earned Leave for Non Government Employee? Is the Limit on Exemption per employer?
Exemption from amount received as leave salary is available under Section 10 (10AA). It is calculated as minimum of the
- There is exemption limit of 3 lakh
- Exemption limit of Rs. 3 lakh is the maximum that one can claim in a lifetime.
- So If you have claimed a tax exemption of Rs 1,00,000 during a financial year on leave encashment then a maximum exemption of Rs 2,00,000 can only be claimed in the future years.
What is Tax on Leave Encashment in leaving job for Non Government Employee?
The Non exampt amount received for encashing leave would be taxed under head Income from Salary and would be Amount Charged to Tax = Amount received as Leave Encashment – Amount exempted
Examples of Earned Leave Encashment , Exemption and Tax
Government Employee encashes leave while working in same organization
Mr. Rupesh is a Government employee. He is entitled to 25 days’ leave per year. He has credit of 252 days’ leave in his account. During the year 2015-16 he encashed leave of 52 days and received Rs. 52,000 on account of leave encashment. In this case, Rs. 52,000 will amount to encashment of leave during the continuation of service and will be fully taxed in his hands.
Non Government Employee encashes leave while working in same organization
Mr. Rupesh is working in Essem Ltd. He is entitled to 28 days’ leave per year. He has credit of leave of 384 days in his account. During the year 2015-16 he encashed leave of 84 days and received Rs. 84,000 on account of leave encashment. In this case, Rs. 84,000 will amount to encashment of leave during the continuation of service and will be fully taxed in his hands.
Government Employee encashes leave on retirement
Mr. Rupesh is a Government employee. He is entitled to 28 days’ leave per year. He has credit of leave of 484 days in his account. He retired in the year 2015-16. He received Rs. 4,84,000 on account of leave encashment at the time of retirement. In this case, Rs. 4,84,000 will amount to encashment of leave at the time of retirement and will be fully exempt from tax.
How to calculate exemption earned in encashing leaves in case multiple employers?
In April 2014, Mr. Kumar retired from Essem Ltd. and received leave encashment of Rs. 84,000. Entire amount qualified for exemption. After his retirement from Essem Ltd. he joined SM Ltd. In March 2016, he retired from SM Ltd. and received leave encashment of Rs. 2,00,000. In this case, the maximum amount of exemption in respect of leave encashment received from SM Ltd. will be limited to Rs. 2,16,000 (Rs. 3,00,000 less Rs. 84,000 claimed earlier).
How much will Non- Government employee get on encashing leave on retirement
Mr. Kumar retired from Essem Ltd. (a private sector company) on 1-1-2016, after serving for a period of 25 years and 9 months. As per service rules, he is entitled to leave of 35 days for each completed year of service. Following are the details:
- Leave availed during service period 184 days
- Leave encashed during earlier years 252 days
- Leave encashed during the year 2014-15 (Rs. 88,000) 44 days
Step 1: Computation of earned leave standing to credit at the time of retirement
If leave entitlement as per service rules exceeds 30 days per year, then it should be restricted to 30 days. Hence. while computing leave standing to credit, we will consider 30 days per year. Detailed computation will be as follows:
| Particulars | Days |
| Total leave available during the tenure of service (30 days × 25 years)
[period of 9 months (i.e., fraction of year) is to be ignored] |
750 |
| Less: | |
| a)Leave availed during service period | 184 |
| b)Leave encashed during earlier years | 252 |
| c) Leave encashed in previous year 2015-16 | 44 |
| Leave standing to credit at the time of retirement | 270 |
| (÷) Days in month | 30 |
| Leave credit at the time of retirement | 9 months |
Step 2: Computation of average monthly salary
As per section 10(10AA)(ii), salary for the purpose of computation of exemption is: 10 months’ average salary immediately preceding the retirement (i.e., day of retirement and not the month of retirement). Salary will include basic salary, dearness allowance forming part of salary while computing retirement benefits and commission based on fixed percentage of turnover achieved by the employee.
- Basic salary per month during 10 months preceding retirement Rs. 40,000
- Dearness allowance (per month) during 10 months preceding retirement: (a) Forming part of salary for computing retirement benefits Rs. 20,000 (b) Not forming part of salary for computing retirement benefits Rs. 10,000
- Children’s education allowance Rs. 1,000 per month for his two children.
- Medical allowance of Rs. 2,000 per month.
- Value of perquisites provided by the employer during the month Rs. 8,400. There is no change in the above pay structure throughout the year 2015-16.
| Particulars | (Rs.) |
| Basic salary per month, for 10 months immediately preceding the retirement | 40,000 |
| Dearness allowance per month (forming part of salary while computing retirement benefits) | 20,000 |
| Total monthly salary for the purpose of computing exemption | 60,000 |
There is no need to convert aforesaid monthly salary of Rs. 60,000 into average monthly salary, since there is no change in salary during past 10 months.
Step 3: Computation of cash equivalent to earned leave:
Leave standing to credit at the time of retirement × Average monthly salary = 9 months × Rs. 60,000 = Rs. 5,40,000
Step 4: Calculation of exemption
As per section 10(10AA)(ii), exemption in respect of leave salary received by a non-Government employee is least of the following:
| Particulars | (Rs.) |
| Cash equivalent to earned leave (step 3) | 5,40,000 |
| 10 months’ average salary (step 2) (60,000 * 10) | 6,00,000 |
| Maximum amount specified by the Central Government | 3,00,000 |
| Amount of exemption under section 10(10AA)(ii) will be least of above. | 3,00,000 |
Step 5: Computation of Total leave salary taxable.
Leave salary received at the time of retirement is Rs. 7,90,000
| Particulars | (Rs.) |
| Total leave salary received at the time of retirement | 7,90,000 |
| Less: Leave salary exempt under section 10(10AA)(ii) (step 4) | 3,00,000 |
| Taxable leave salary | 4,90,000 |
| Leave encashment of 44 days received during the year 2015-16 | 88,000 |
| Total taxable leave salary | 5,78,000 |
Why rules are different for government and non government employees?