Leave Encashment - Tax Exemption, Calculation & Examples

Every salaried person is entitled to a certain number of leaves to their kitty. However, this would not necessarily mean that the employee has utilised all their leaves. Let us understand how leaves that get accumulated until retirement, when encased at the time of retirement, get treated from a taxation point of view. With the help of this information, individuals may be encouraged to plan their taxes in advance.

Generally, employees are allowed to take leave during the period of service. There are various possibilities that can arise when leaves get allotted to an employee.

1. The employee may avail such leave
2. The employee may not avail such leave but encash it in future during the term of employment
3. The employee may not avail such leave but encash it at the time of retirement, whether on superannuation or otherwise
4. The leaves may lapse, depending on the employer’s H.R. policies.

The payment received on account of encashment of unavailed leave would form part of salary. Leave salary encased during the period of service is fully taxable.However, section (10)(10AA) of the Income Tax Act provides certain relaxations from tax to amounts received on account of unutilised leaves during retirement. The provisions of this clause are:

Points to be Noted

• It should be noted that earned leave entitlement cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired.
• Salary for this purpose means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits and commission which is expressed as a fixed percentage of turnover.
• If leave is encashed during employment, the entire amount is taxable under the head “ income from salary”. One can still opt for exemption when filling for returns.

In cases where leave salary is received from two or more employers in the same year, then the aggregate amount of leave salary exempt from tax cannot exceed three lakh rupees. Additionally, where leave salary is received in any earlier year from a former employer and again received from the new employer in a later year, the limit of three lakh rupees will be reduced by the amount of leave salary exempt earlier.It is financially prudent to decide in advance whether to encash unutilised leaves annually on a systematic basis or receive a lump sum amount at the time of retirement or resignation. One may consider factors like liquidity needs, retirement goals, cost of inflation, time value of money, etc. so as to make an informed decision.

Many businesses permit employees to carry over unused vacation time that can be used when they retire or quit their jobs. The Leave Encashment Tax applies without any exception to the sum received utilizing this facility.As a salaried worker, you are entitled to a variety of leave options, including annual, earned, and sick leave. These leave days might be carried over into subsequent years in some cases. You are permitted to carry over the remaining leave days indefinitely in many businesses and all government organizations.When such an opportunity is available, it is possible that you will be able to return unused vacation time to the employer and receive payment in exchange when you resign or retire. You will be compensated for all the leave you were eligible for but did not take. It's known as leave encashment.

Any leave may be redeemed while a person is still employed, when they retire, or when they resign. It is fully taxable and qualifies as income from salary when cashed out during the service period. The income you will receive for leave encashment may be quite significant if you are turning in a lot of leaves. Particularly true for those working for the government. When taking into account a tax on leave encashment, the subsequent criteria must be met:

• If you use your vacation time while still employed by the firm or government agency, you will be taxed on the whole amount.
• Government personnel are not obligated to pay tax on leave encashment income during the term of retirement or resignation, whether they work for the Central Government or the State Government.
• Private sector employees' leave encashment payments made following retirement or resignation are taxable as "Income from Salary." But this revenue is subject to some exemptions. The leftover sum will be transferred to normal income and taxed in accordance with the income tax brackets once the exemption has been taken into account.
• Employees in the private sector are excluded from paying income tax on leave encashment under Section 10. (10AA).

You must be aware of the many types of leaves and which among them can be encashed in order to cash in your leaves. The following are many leaves types:

Casual Leave

Employees most frequently take this type of leave. The length varies from business to business, but a limit of seven to ten days is typically permitted. The organisation has its own specific policy, and the employee is required to advise the employer of their casual leave, its duration, and the date they will return. Your leave will be liable for cash encashment if this is approved.

Privilege Leave

An employee may take a privilege leave if prior notice of the vacation has been given to the organisation and it has been approved. Although the rules for cashing in privilege leave vary from organisation to organisation, it becomes redeemable after a certain amount of time.

Medical Leave

If an employee's health prevents them from working, they may request medical leave. For this, they must let the employer know about any upcoming leaves. These can be redeemed for leave after being sanctioned. Depending on the organisation, a different amount of leaves are permitted. Long-term medical leaves, however, are not eligible for the cash leave encashment period.

Sabbaticals

Employers also grant their staff members time off to advance their education and get new skills. These are available through a variety of courses. These are paid leaves that are eligible for leave encashment because an organisation reimburses them.

Holiday Leave

Holiday leave is also paid time off, and no money is deducted from an employee's pay during this time. These can also be redeemed for leave.

Maternity Leave

Every pregnant female employee has access to maternity leave for the duration of their job. It could last anywhere from 12 to 26 weeks during pregnancy. Although it is possible to extend this, the additional time will not be compensated. Additionally, every organisation has a different maternity leave policy. These aren't taken into account for encashment.

Here is the formula for calculating leave encashment: [(BS + DA) / 30] x Number of EL Here, BS stands for Basic Salary, DA stands for Dearness Allowance, and EL stands for Earned Leave.Here is an illustration to help you grasp how the leave encashment is determined:Twenty years of service later, Mr Prasad is retiring. He was qualified for 25 days of paid leave each year from the employer, giving him a total of 500 days of leave.Mr Prasad has already used 150 days of his paid leave from this. He still has 350 days of unused vacation.At the time of retirement, he received a base income and a dearness allowance of Rs 35,000 per month.Now, the number of unused leaves is multiplied by the salary per day, which results in the following calculation for leave encashment: Per day salary =Rs. 35,000/30 = Rs. 1167/- (approximately)
Received leave encashment equals 350* Rs.1167 or Rs. 4,08,450/-As a result, Mr Prasad was given Rs 4,08,450 as leave encashment.

The total amount of leave salary that is free from tax cannot exceed three lakh rupees in circumstances when leave salary is obtained from more than one employer in the same year. Additionally, the three lakh rupee limit would be decreased by the sum of leave salary that was exempt prior in cases where leave salary was received from a previous company in any previous year and again from a future job in a later year.It is financially wise to determine in advance whether one should receive a lump payment at the time of resignation or retirement or to annually cash in unused leaves on a regular basis. To make an educated choice, one may take into account elements such as cash flow requirements, retirement objectives, inflation rates , time worth of money, etc.

The maximum number of leaves that a worker may take during their employment and the maximum number of leaves that may be redeemed is 300 days.

No, casual leaves run out at the end of the year. No earned leaves or sick days may be combined with casual leaves. Unused casual leaves cannot be cashed in, in contrast to earned and privileged leaves.

Government personnel are not taxed on it, although non-government employees may be partially free from taxes under section 10(AA) of the income tax exemption act (II) .

The leave days that an employee is entitled to during their employment tenure. They are typically permitted to take one day off for every 20 days of work.Ready to make the most of your money? Start your tax planning journey now!

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.