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Leave Encashment Calculation & Tax Exemptions

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Leave Encashment Calculation & Tax Exemptions

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According to Indian labour laws, every employee has the right to take a specific number of paid holidays each year, which are also included in the benefits provided by their company. In case you do not use some of these leaves, you can choose to encash them. 

Here, we will detail the different aspects of leave encashment calculation, including the types of leave encashment and how to calculate leave encashment.

What is Leave Encashment? 

Simply put, the term ‘leave encashment’ refers to the ability of an employee to encash any unused paid leaves either at the time of leaving an employer, retiring, or otherwise continuing their employment. When an employee resigns or is terminated by a company, the full-and-final settlement includes the individual's accrued vacation time. 

How Does Leave Encashment Exemption Apply to an Employee?

If you are wondering how leave encashment exemption works, here are certain factors you need to take note of, to begin with:

  • Every person who receives a salary has a specific number of paid leave days provided by his or her employer each year.
  • Most firms permit their workers to carry over unused paid time off.
  • When an employee resigns or retires, the employer is responsible for compensating for any remaining paid time off in accordance with the company's policy.
  • One company's leave encashment policy might not be the same as another.

The Different Types of Leaves

If you’re working in a company, you’d probably be aware of the many types of leaves which could be encashed.

1. Casual Leave

Employees most typically use this kind of leave. The employee must notify the employer of their casual leave, including the duration and date they want to return, in accordance with the organisation's specific policy. If you do not use it, you would be able to cash out your leave.

2. Privilege Leave

If the employer has been given advance notice and the leave has been approved, the employee may take a privileged leave. Even though each organisation has its own set of rules for redeeming privileged leave, it eventually becomes encashable.

3. Medical Leave

Employees may ask for medical leave if their health prevents them from working. A varying number of leaves is allowed depending on the organisation. However, the monetary leave encashment window is not available for long-term medical leaves.

4. Maternity Leave

For the term of their employment, any pregnant female employee is eligible for maternity leave. This leave could last anywhere from 12 to 26 weeks of pregnancy.  It is possible to prolong this, but the extra time will not be paid for. Every organisation also has a unique maternity leave policy. For encashment, these are not taken into consideration. 

Leave Encashment Exemption & Taxation

When a Central or State Government employee retires or resigns, any leave encashment they get is completely exempt. Legal heirs of a deceased employee who gets leave encashment are also completely exempt. 

Any leave may be redeemed while still on the job, upon retirement, or upon resignation. It is fully taxed when cashed during the span of the service period and counts as salary income. However, Section 89 of the Income Tax Act allows for some relief to be claimed.

Tax planning can be done by determining whether it is advantageous to cash in leave each year or receive a lump sum payment at the time of retirement or resignation based on the employer's leave encashment policy and the individual's income. Before making a decision, one may also consider the cost of inflation.

The Bottom Line

An individual can choose whether it is better to cash in leaves each year or wait for a lump sum payment at the time of retirement or resignation based on their salary.

Frequently Asked Questions

1. What is the formula to calculate leave?

The leave encashment formula is [(Basic Salary + Dearness Allowance) / 30] * Number of EL or earned leaves. 

2. How are 10 days of leave encashment calculated?

Cash equivalent is calculated as follows: (Pay admissible on the date of claiming the Leave Travel Concession + Dearness Allowance admissible on that date/30) * Number of days EL, with a maximum of 10 days at once. The House Rent Allowance is not considered when calculating the cash equivalent according to the formula above.

3. How to calculate earned leave encashment?

Here is the leave encashment exemption calculation for non-governmental employees: 

Received leave encashment - Exemption as per Section 10(10AA). 

4. How to calculate encashment exemption?

Employees working for non-government organisations are only exempt to the extent of the lowest of the following:

  • The actual amount of paid leave 
  • Average compensation for the past 10 months
  • For each year of service that has been completed, salary per day * unused leave (taking the annual maximum of 30 days off into consideration)

The above mentioned compensation consists of a base salary, a dearness allowance, and commissions calculated as a fixed percentage of the employee's secured turnover.

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