A salaried employee would have access to various types of paid leave. These could be casual leave, sick leave, general leave, or earned leave. Some of these leaves can be carried forward to the following years, according to the employer’s rules. There is also the possibility of encashing some of these leaves. This process is known as leave encashment.
Leave encashment takes place when you convert unused leave days into cash.
Leave encashment is the compensation the employee receives in return for any unused leaves. Instead of taking leave, the employee opts to work on those days and gets paid for those days of work. Such a payment is usually made at the time of retirement, resignation, or even during the service period, depending on the company's policy.
Here are some of the various types of employee leaves
This is the kind of leave that is most commonly available and can be taken for a maximum period of seven days at a stretch. However, it will be based on the guidelines set by the employer.
Before taking casual leave, the employee generally needs to inform the employer of the plan to take such leave and the number of days of casual leave to be taken. Casual leaves can be considered for leave encashment if they are allowed to be carried forward according to the company's policy.
The employee needs to inform the employer beforehand to avail of this leave. This leave is sanctioned by the employer, and the employee is paid during the period of this leave. If the employee does not avail of this leave in a year, it can be accumulated and encashed later.
However, every organisation has its own set of rules for leave and leave encashment.
Employees use this leave when they are unwell and unable to work under regular settings. Because this is an emergency leave, the employee is not required to provide previous notice to the employer while taking this leave.
The quantum of medical absence provided to employees varies per organisation; these leaves are compensated.
This leave is given to pregnant female employees during their employment period. This is paid leave, which can range from 12 weeks to 26 weeks.
This leave is provided to employees who wish to broaden their expertise by taking various appropriate institutional courses. They can participate in any specialised training or workshop related to their line of employment, as well as enroll in long-term courses at universities.
If an infectious disease occurs in an employee's family or community, the employee may request quarantine leave. Granting this leave may protect other employees from getting infected with the illness.
This form of leave is not considered for leave encashment.
This leave is especially given to employees who have become fathers. In India, only government employees are eligible for paternity leave benefits. The parent employee may be allowed 15 days of leave before or following the birth of a child.
This leave is also not considered for encashment.
In order to encash leaves, you need to follow these two main steps:
Employees may make a written request to the HR department or fill out a leave encashment form.
The HR department will compute the encashment amount in accordance with the company's policy, which often includes multiplying the employee's daily income by the number of days being encashed.
Here’s how tax is calculated on leave encashment-
Any employee who wishes to encash leaves during the employment period is liable to pay tax, as such, a payment becomes part of the salary. However, the employee can seek tax relief under Section 89.
According to Section 89, the employee can claim tax relief for the amount received through the leave encashment process.
Employees can encash their unused leaves after retirement or even resignation. However, the conditions for this vary depending on the organisation. Ensure that you read and understand these conditions set out in your employment contract well in time to avoid disappointment.
Section 10(10AA) of the Income Tax Act, 1961, provides for the tax treatment of leave encashment received by an employee. The taxability of leave encashment depends on various factors, such as whether the employee is a government or non-government employee and whether the leave encashment is received during service or at the time of retirement or resignation.
Provisions associated with Section 10(10AA) are-
Leave encashment received by government employees at the time of retirement (including on superannuation or otherwise) is fully exempt from tax.
Leave encashment received by non-government employees at the time of retirement or otherwise is exempt from tax to the extent of the least of the following:
Suppose a non-government employee named Kumar retires and receives a leave encashment of Rs 4,00,000. The details are as follows:
Average salary of the last 10 months: Rs 50,000 per month.
Leave balance: 150 days (5 months equivalent).
The exempt amount will be the least of the following
Therefore, the exempt amount is the least of these amounts, which is Rs 2,50,000. The remaining Rs 1,50,000 (Rs 4,00,000 - Rs 2,50,000) will be taxable.
Section 10(10AA) provides a clear framework for the tax treatment of leave encashment, offering significant tax relief to retiring employees. Understanding these provisions helps employees plan their finances better and ensures compliance with tax laws.