Leave encashment means that if a certain employee of an organisation is yet left with paid leaves, they can encash those leaves. The Leave encashments are done during a specific period. If you are a government employee, your leave encashment is exempt from tax, but if not, there might be some certain taxations that would happen to your leave encashments. For such encashment to happen, there is a calculation of leaves as well as the amount is calculated based on certain parameters, basic pay and the dearness allowance.
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Only earned leaves and half pay leaves are considered in the leave encashment calculations, and the taxation is also treated at the time of the leave encashment calculation.
Concept of Leave Encashment
The concept of leave encashment applies if an employee has left with some not availed leaves, then they can get an amount in exchange for that period. The amount is calculated differently in different organisations, although it is consistent for the government employees. The leave encashment rule covers all of the regular employees of a particular firm. If there are any contingent for the government, they will be worked under how the government calculates leave encashment. The leave encashment can be taken or claimed by an employee when it is their time of retirement or when the employee leaves a company. Some of the schemes would let the employees carry forward the excess leaves to the next consecutive year.
The earned leaves (EL) and half pay leaves (HPL) are counted collectively.
There is a maximum limit for leave encashment of 300 days, and in a month, only 30 days are considered. So, 300 days are divided by 30 days, resulting in 10 months. The leave encashment is made on the last basic pay and dearness allowance (DA).
Leave encashment that employees receive when they retire from their job: If any leave is left for an employee to use, he shall be allowed to encash the unveiled portion of the earned leave.
When an employee retires from their job: The employee shall be paid leave encashment adjusted salary if there are leaves left to use or are in credit of unearned leave.
When they are dismissed from their job: Employees who are terminated or removed from service will not be able to encash their leave. A termination implication will entitle the employee to encash earned leave as per the rules. Nominees shall be paid the salary for earned leave declared for this kind of funds or to their legal kin if the nominee is not mentioned.
When they are in service: Earned leave may only be redeemed once every calendar year ends, at the employee's choosing. The amount of leave encashed in any individual case must not exceed half of the earned leave or 30 days of the earned leave, whichever is lesser.
How to Calculate Leave Encashment
Let’s understand the calculation of leave encashment with an example.
(1) Leave Account
Balance Earned Leaves (EL): 250
Balance half pay leaves (HPL): 150
Maximum leaves allowed for encashment: 300
EL authorized for encashment: 250
HP authorized for encashment: 50
Total leaves authorized for encashment: 300
(2) Last salary detail
Last basic pay (BP): ₹ 70,000
DA 17%: ₹ 11,900
Total emoluments (BP and DA): ₹ 81,900
Half of emoluments: ₹ 40,950
Calculation of earned leaves (EL) encashment
EL or earned leaves authorized for encashment: 250
Total emoluments (BP and DA): ₹ 81,900
EL encashment: (total emoluments / 30) x number of earned leaves
= (81900 / 30) x 250
= ₹ 6,82,500
Calculation of half pay leaves (HPL) encashment
HPL authorized for encashment: 50
Half of emoluments: ₹ 40,950
HPL encashment = (half emoluments / 30) x number of HPL
= (40950 / 30) x 50
= ₹ 68,250
Total encashment = EL encashment + HPL encashment
= ₹ 7,50,750
Tax Treatment for Leave Encashment
There are some leaves that can be encashed the following year, and employees can choose for the encashment of those leaves they didn't avail. Both private and government employees are eligible for several types of leave, including sick leave, casual leave, earned leave, and privileged leave. The taxation depends on whether they are non-government or government employees. If an employee can choose to encash leaves during the course of their work, the entire amount will be paid under the heading "income from salary". However, the exemption is limited to a certain amount at the time of filing for returns.
- Leave encashment that legal heirs of the deceased employee may receive is fully exempt from taxation.
- If a non-government employee receives leave encashment, it is exempt based on the computation provided under income tax exemption section 10(AA) (II).
- Leave encashment allotted by central or state government employees when they retire or resign is fully exempt from taxation.
Let us take a simple example to understand how to calculate leave encashment taxation.
Satish is retiring after 15.1 years of service.
Satish was entitled to 35 days of leave per annum from his company, which comes to about 525 days of leave for the service he gave to his company.
Satish has already taken 200 days of paid leave.
He is now left with 325 days of unused leave.
Satish has pay of ₹ 33,000 per month when it the time of retirement
He received ₹ 3,57,550 as leave encashment calculated based on 325 days X ₹ 1,100 (pay per day = 33,000/30 days).
- The average month's pay of the last ten months
- The highest that the government allows is ₹ 3,00,000
- Cash equivalent of paid leaves (max 30 days) for every year of service made.
Leave encashment received
₹ 3,57,550 (325 days x ₹ 1,100)
Least of these:
1. The authorised amount by the govt
2. Actual leave encashment
3. Average the salary for last ten months – ₹33,000 x 10
4. ₹ 1,100 x (30 days x 15 completed year of service - 200 days of used leave)
Leave encashment taxable as income from salary
- When you leave a job by termination or resignation, the amount claimed as leave encashment is entirely yours.
- Proceeds collected towards leave encashment are chargeable if received by an employee in service.
- The leave encashment amount received at retirement is exempt from taxation.
- The value of leave encashment is viewed as income from payroll and taxed at the employee's specific tax slab rate under income tax rules.
Leave Encashment Requirements
- An individual worker should not utilise all the leave he is entitled to avail in a year.
- Most companies provide the employees with the option of carrying forward such unused paid leaves.
- Leave encashment under rule 5.1 while in service, an employee shall be required to apply in writing to the sanctioning authority. In all other cases, it shall be settled by the appropriate authority.
Not all kinds of leaves are considered for leave encashment, and different types of organisations deal with leave encashment differently. If you are a government employee, then various government policies will apply. Section 10(AA) (II) will have an exemption for the leave encashment. Depending on when employees are cashing their leaves, the treatment could differ.