INDEX
Leave Encashment
Budget 2023 Update
What is Leave Encashment?
What are the Types of Leaves?
Taxation of Leave Encashment
Leave Encashment at the Time of Retirement or Resignation
Leave Encashment Calculation
Leave Encashment
Introduction
Leave encashment is a concept commonly known to salaried individuals. It refers to the idea that unused leave days can be converted into income. This article explains the meaning, tax implications, and calculation methods for leave encashment.
Budget 2023 Update
Leave encashment for non-government employees is exempt from tax up to a certain limit. This limit, which had been Rs. 3 lakh since 2002, has now been increased to Rs. 25 lakh due to the general rise in salary income.
What is Leave Encashment?
According to labor law, every salaried employee is entitled to a minimum number of paid leave days each year. However, employees are not required to use all the leave days granted within the year. Many employers offer the option to carry forward unused paid leave.
Over time, employees may accumulate unused leave, leading to compensation for these unutilized paid leave days. This practice is known as leave encashment.
Types of Leaves
The types of leaves typically outlined in a company’s leave policy are:
Casual Leave: For personal reasons, typically ranging from 7 to 10 days. Encashment varies across companies.
Earned Leave (Privilege Leave): Requires prior notice and is often eligible for encashment after a specific period.
Medical Leave: Granted for health issues; the number varies by organization.
Holiday Leave: Allocated for official holidays with no salary deductions.
Maternity Leave: Ranges from 12 to 26 weeks, not eligible for encashment.
Sabbaticals: Granted for personal development; reimbursement policies vary
Leave Encashment Received During Service
Leave encashment received by employees is subject to tax depending on when it is received. If an employee receives leave encashment while still employed, the amount is fully taxable and is considered part of their “Income from Salary.” However, tax benefits can be claimed under Section 89 of the Income Tax Act. To avail of this tax relief for salary arrears on leave encashment, the employee must complete Form 10E. This form can be filled out and submitted online through the income tax portal.
Taxation of Leave Encashment
Leave Encashment During Service
Leave encashment received during service is fully taxable and considered part of “Income from Salary.” However, tax relief under Section 89 of the Income Tax Act may apply. Employees must submit Form 10E online through the income tax portal to claim this relief.
Leave Encashment at Retirement or Resignation
The taxability of leave encashment at the time of retirement or resignation depends on:
State and Central Government Employees: Fully tax-exempt.
Non-Government Employees: Partly exempt based on Section 10(10AA)(ii).
Legal Heirs: Fully tax-exempt if received by the legal heir of a deceased employee.
Leave Encashment Calculation
The formula for calculating the leave encashment exemption for non-government employees is as follows:
Exemption under Section 10(10AA) will be the least of the following:
- Amount notified by the Government (₹25,00,000).
- Actual leave encashment amount.
- Average salary of the last 10 months.
- Salary per day * unutilized leave.
Important Notes on Taxation:
Definition of Salary: Includes basic salary, dearness allowance, and commission based on turnover.
Lifetime Limit: The Rs. 25,00,000 exemption is applicable across all employers during an employee’s career.
Multiple Employers: If leave encashment is received from multiple employers in the same financial year, the maximum exemption limit is Rs. 25,00,000.
Tax Regime Applicability: Exemption applies under both old and new tax regimes.
Leave Encashment Exemption Illustration
Let’s understand leave encashment exemption with an example:
Example:
Service Duration: 15 years
Leave Entitlement: 35 days per year (total: 525 days)
Leave Utilized: 200 days
Basic Salary + DA: Rs. 33,000 per month
Encashment Amount: Rs. 3,57,500
Calculation:
| Particulars | Amount (Rs) |
| Leave encashment received | 3,57,500 |
| Less: Exemption | 2,75,000 |
| – Amount notified by Government | 25,00,000 |
| – Actual leave encashment | 3,57,500 |
| – Average salary for last 10 months | 3,30,000 |
| – Rs. 1,100 * Unutilized Leave (325 days) | 2,75,000 |
| Taxable Leave Encashment | 82,500 |
Explanation:
The least of the exemption criteria (Rs. 2,75,000) is tax-exempt.
The remaining Rs. 82,500 is taxable as “Income from Salary.”
Tax Planning Consideration
Employees should plan whether to encash leave annually or at retirement based on their employer’s policies and personal financial goals. Inflation and tax implications should also be considered.
Frequently Asked Questions
- Are leave encashment and leave salary the same?
Leave salary is a part of leave encashment that accumulates over time and is encashed later. - Is leave encashment taxable?
Yes, leave encashment is taxable. However, the taxation rules vary depending on the sector and the employer. - Is there a change in the leave encashment limit in 2023?
Yes, the exemption limit for leave encashment has been increased from Rs. 3 lakh to Rs. 25 lakh for non-government employees. - Can I use the entire limit of Rs. 25,00,000 for leave encashment if I have availed of the exemption earlier?
No, the Rs. 25,00,000 exemption limit is applicable for a lifetime. Any exemption claimed in the past will reduce the remaining limit, and the total exemption will not exceed Rs. 25,00,000. - Will I get exemption for leave encashment under the new tax regime?
Yes, leave encashment exemption is available under the new tax regime as well.