Leave encashment refers to paying money against unused leaves. Leave encashment is a benefit given to an employee by its employer. Leave encashment can be availed during service period and at the time of retirement. It is important to know about leave encashment for better leave planning. It also helps in taking time off from work and monetary benefits. We will discuss here in details about leave encashment.
Understanding leave encashment
As per Indian laws, an employee is entitled to a certain number of paid leaves annually, which are among the benefits offered by their employer. There are different types of leaves which an employee can avail during his service period. Out of these ordinary or earned leave which are not availed otherwise can be encashed or received as money as per norms.
Different organisation has different rules for eligibility of ordinary or earned leave. In some organisation, it is 2.5 days per month, in others one day per eleven days. Further there are rules on how much ordinary or earned leave can be accumulated by not availing leave during service period. Also there are rules on how many days can be encashed out of the accumulated leaves.
Type of leaves
There 7 major type of leaves as below:
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Casual Leaves
As the name suggest it can be taken at any time during a calendar year as per wish of the employee for rest, family function or any other personal reasons. In India, companies typically offer one to two casual leaves per month, with the exact number varying from state to state, organisation to organisation. Although there is no legal provision specifying the number of casual leaves, most companies provide employees with eight to fifteen casual leaves annually.
It is important to note that casual leaves cannot be combined with other types of leaves and in most cases cannot be carried forward to the next year or encash. Therefore, if casual leave is not availed during the year, it will lapse. The purpose of casual leave is to help the employee maintain a healthy work-life balance throughout the year.
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Ordinary or earned Leaves
An ordinary or earned leave (OL/EL) is an annual entitlement for employees who work in an organisation for minimum a year. The exact number of OL/EL can vary from one organization to another. Generally, OL/EL is used for taking long duration leave by employee for which prior permission is required from supervisor. Unutilised leaves during the year is accumulated and carried forward to the next year. Among all type of leaves OL/EL is the only one which is considered for encashment.
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Medical or Sick Leaves
Sick leave or medical leave is granted against medical exigencies. If the employee is required to take rest or hospitalised, he or she can avail this leave by showing medical certificate. It is over and above other type of leaves. As per Indian law, employers are required to provide minimum 15 days sick leave annually to its employees. Employer may wish to give higher number of days as sick leave per year.
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Maternity Leaves
In India, women have the legal right to take up to six months of maternity leave for the management of pregnancy and postpartum recovery, as per the Maternity benefit Act 1961. Women can also avail of maternity leave in case of miscarriage or abortion. The duration of maternity leave offered may vary depending on the employer, and it is typically the most extended break provided among all types of leaves for employees.
Under the law, women employees can also extend their maternity leave for up to 16 months without the risk of termination. However, it is at the company’s discretion to decide how many days of this extended leave duration will be unpaid.
There is restrictions on number of times maternity leave can be availed during once employment tenure. Usually, it is not more than 2 times. Maternity leave can also be availed for legal adoption, surrogacy, hysterectomy, gynaecological ailment.
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Paternity Leaves
As women are entitled to maternity leave, male workers also have the right to paternity leave. Paternity leave is an essential type of leave that enables new fathers to spend time with their newborn child and support their partners.
The duration of paternity leave may vary depending on the company’s policy. However, it is usually a few days to a couple of weeks. Paternity leave is typically offered during the final days of pregnancy or immediately after the baby’s arrival. All organisations have not adopted paternity leave policy. However, it is catching up fast.
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Leaves without pay
Leave without pay, also referred to as unpaid leave, is an option for employees who need to take time off from work but have exhausted all their paid leaves. Employer in such case adjust the absence without pay. In the process, employee loss seniority or continuity of service for the absence period. However, his job remain intact.
Employees can request for unpaid leave in extreme scenarios and unexpected circumstances. Each organisation has laid down leave policy. Unpaid leave should be within the ambit of such policy for an employee to avail it.
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Compensatory Off Leaves
Compensatory offs or comp-offs are a way for companies to recognize and appreciate the hard work of their employees who work on non-working days or put in extra effort to complete their assignments. These off days are given to employees as a reward for their dedication and commitment to the company.
Comp-off policies vary from one company to another, and they can be given in the form of extra paid leaves or time off. Employers usually track the extra hours worked by employees and offer comp-off accordingly.
There could be other type of leaves as well. However only earned and ordinary leave is considered for leave encashment.
Leave Encashment Calculation
The formula to calculate the leave encashment amount is as follows:
Leave Encashment Amount = (Basic Salary + Dearness Allowance)/30 x Number of Leave Days
The basic salary refers to the fixed amount paid to an employee before any allowances or bonuses are added. Dearness Allowance is a component of salary paid to mitigate the impact of inflation on employees.
Example : The basic salary of Mr. X is ₹30,000/- , dearness allowance is 40% of basic pay i.e. ₹30,000 X 40% = ₹12,000/-. Mr. X propose to encash 15 days of leave during his service. The eligible amount will be (30,000 + 12,000)/30 X15 = ₹21,000/-.
Let’s assume Mr. X is retiring after 20 years of service. During his employment, Mr. X was entitled to 33 days of earn leave per year, which adds up to a total of 660 days of leave over his entire tenure. He used 300 days of earn leave during service period, leaving him with 360 days of unutilized leave. The leave policy of the organisation allow encashment of only 260 days leave at the time of retirement. The balance unutilised leaves will lapse.
At the time of his retirement, Mr. X’s basic salary plus DA was ₹ 65,000 per month. Applying the above formula, he will receive ₹ 5,63,333 as leave encashment.
Tax on Leave Encashment
Leave encashment during service period is considered as income and added to salary income
to calculate applicable tax. However, leave encashment at the time of retirement or resignation is treated as below for tax purpose:
- If government employee – fully exempted from tax
- Deceased government employee’s legal heirs receive leave encashment – completely exempt.
- By any other employer, least of the following is exempted from tax under section 10(10AA)(ii) of IT Act,
- ₹25 lakh ( enhancement from earlier limit of ₹3 lakh in last budget)
- Leave encashment actually received
- 10 month’s salary (on the basis of average salary of last 10 months preceding retirement or resignation)
- Cash equivalent of unutilised leave (based on last 10 months average salary) at the time of retirement/resignation subject to annual entitlement of earned leave maximum 30 days.
In the above example,
- actual leave encashment received is ₹5,63,333/-.
- 10 month’s salary is ₹6,50,000 (assuming last 10 months average salary ₹65,000),
- Cash equivalent of unutilised leave is ₹7,80,000/- (with average salary of ₹65,000/- per day salary works out ₹2167/- multiplied by number of unutilised leave i.e.360 days)
It can be seen from above 4 options, least is actual leave encashment. Therefore this amount will be exempted from total income to calculate tax liabilities.
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