GUIDESMONEY MATTERS
Leave Encashment Calculation and Taxation with Examples
6 MIN • 
LAST EDITED BY SAYAN DAS ON FEBRUARY 28, 2025.
LAST EDITED BY SAYAN DAS ON FEBRUARY 28, 2025.
GUIDES LAST EDITED BY SAYAN DAS ON FEBRUARY 28, 2025.
Did you know you can encash your paid leaves when you retire or resign from a company?
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. You can encash some of these leaves if you do not use them.
Let's understand the different types of leave encashment and the process for leave encashment calculation.
You have worked in a company for the last two years and have 20 paid leaves pending. If your salary is ₹31,000 per month, your daily income will be ₹1,000. You can encash the 20 unused paid leaves at ₹1,000 for each day. So, you will get ₹20,000 extra at the time of your resignation or retirement.
When an employee resigns or retires, the full and final settlement includes the individual's accrued leaves.
Casual leave refers to paid leave given to employees, which can be utilised when they require a few days off due to unexpected/unforeseen personal circumstances. It is typically the most commonly used leave category among employees.
This is one of the most flexible and employee-friendly office leaves. These leaves are paid, which means an employee can enjoy these leaves without any salary deductions. These leaves are encashable, and employees can get paid instead of using these leaves.
Employees may ask for medical leave if ill health barricades them from working. The number of medical leaves may vary from one company to the other. These leaves are neither carried forward nor encashed.
Any pregnant employee is eligible for maternity leave. According to the Maternity Benefit Act of 1961, a first or second-time mother is entitled to a maternity leave of 6 months or 26 weeks. The mother can take a maternity leave of 3 months or 12 weeks for subsequent children. This leave is fully paid, and the employer must provide the mother's full salary during this period.
During your employment journey, any leave encashed goes directly into the taxable column of your salary income—no exceptions. But there's a silver lining: Section 89 of the Income Tax Act offers potential relief that might soften the blow to your wallet. This provision recognises that a lump sum payment shouldn't necessarily push you into a higher tax bracket for that year.
Let's delve into the leave encashment calculation using a practical example involving Mr Rajeev, who is retiring after dedicating 20 years of service to his company.
The computation of leave encashment hinges on multiplying the number of unutilized leave days by the daily salary rate, which is calculated as follows:
Now, the leave encashment amount can be determined as:
Hence, Mr. Rajeev is eligible for a leave encashment payment of ₹4,08,450.
When a Central or State Government employee retires or resigns, any leave encashment they get is entirely exempt. Legal heirs of a deceased employee who gets leave encashment are also wholly exempt.
Any leave may be redeemed while still on the job, upon retirement, or upon resignation. It is fully taxed when encashed during the service period and counts as salary income. However, Section 89 of the Income Tax Act allows for some relief to be claimed.
To ascertain the tax implications, we need to evaluate the tax exemption, which is the least of the following:
Let us take the same example in consideration and calculate the tax exemption for Mr Rajeev.
Therefore, Mr. Rajeev's taxable leave encashment, categorized as 'income from salary,' amounts to ₹1,08,450.
It is essential to know that paid leaves can be encashed when retiring or resigning from a company. Indian labour laws give employees the right to a specific number of paid holidays each year, which can be included in their benefits. If any of these leaves remain unused, employees can encash them. Leave encashment policies may vary among employers. Regarding taxation, leave encashment may be exempt for certain individuals, such as government employees and their legal heirs. Understanding the provisions and regulations related to leave encashment can help employees make informed decisions and utilise their benefits effectively.
The leave encashment formula is [(Basic Salary + Dearness Allowance) / 30] * Number of EL or earned leaves.
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.
Employees working for non-government organisations are only exempt to the extent of the lowest of the following:
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.
The exemption limit for leave encashment from income tax in India is currently set at ₹25,00,000. Any amount received as leave encashment up to this limit is exempt from income tax.
