Taxability of Leave Encashment

An employee is accorded several annual leaves like medical leave, gazetted holidays, casual leaves, and other similar forms of leave. supported the varied employment policies, a number of these leaves are often carried over to the subsequent year, and some of them must be utilized within the same year. Some employers facilitate the worker to encash such leaves as salary. during this article, we briefly discuss the taxability of leave encashment availed by employees.

Time of Encashment

An employee is sometimes entitled to assert encashment at the subsequent stages:

• During the course of ser purpose of retirement/resignation.

• At the purpose of termination.


Encashment obtained by an employee would be treated as salary. As a result of it, leave encashment would be taxed within the hands of the worker as “Income from salary.” In some taxation provisions, leave encashment provides the taxpayer with the advantage of tax exemptions, which is further explained in the article.

The taxability of encashment is calculated by reducing the exempted amount from the sum of cash so received as encashment.

For the aim of income tax, employees are categorized into the following:

• Government employees

• Non-Government employees

Taxpayers should note that leave encashment provided to members of the family on the death of the worker is exempted from taxation.

Concept of Leave Encashment

Every salaried person as per labour law is entitled to a minimum number of paid leave each year. However, it’s not necessary that a personal employee utilizes all the leave he’s entitled to for a year. In fact, most employers allow the staff an option of carrying forward such unutilized paid leaves.

This would invariably leave the worker with an accumulated unutilized leave balance at the time of retirement or resignation from the corporate because the case is also. This compels the employer to compensate the unutilized paid leave of the workers. this idea is best referred to as leave encashment.

Now that we’ve got briefly, understood what leave encashment is, the following step is to know how it’s taxed within the hands of the recipient

Taxation of Leave Encashment

Leave encashment received during service

Accumulated exit can either be encashed during service or at the time of retirement or resignation. Any vacate encashed during service is completely taxable and forms a part of ‘income from Salary’. However, relief under Section 89 may be claimed (refer to this circular).

Leave encashed at the moment of retirement.

Leave encashment earned at the time of either retirement or resignation is either entirely or partly exempt depending upon the classification that an employee falls under. This has been elaborated further below:

• Leave encashment received by Central or authorities employee at the time of retirement or resignation is fully exempt

• Leave encashment received by legitimate heirs of a deceased employee is entirely exempt

• Leave encashment received by Non-Government worker is exempt supported the computation provided under Section 10(10AA)(ii) and the balance amount if any is taxable as ‘income from salary

Encashment Received During Service

Encashment received during the course of service is entirely taxable within the hands of the Governmental and Non-governmental employees. However, the assessee is entitled to assert relief under Section 89, if applicable. Section 89 of the tax act consists of provisions that let a taxpayer say exemptions for the receipt of arrears/advance salary, gratuity, compensation on termination of employment, and payment of commutation of pension.

Leave Encashment on Retirement/Resignation

Leave encashed by a Government employee at the time of resignation or cessation of services is entirely exempt from tax. On the opposite hand, leave encashed by the other employee in an exceedingly similar scenario is exempt to a specified limit. The exemption is the smallest amount of the subsequent specified below:

• Cash received for the leaves not availed. this can be derived by multiplying the amount of earned leaves in months by the typical monthly salary.

• The average salary for the previous 10 months.

• Leave encashment received during retirement.

• Rs 3,00,000.

Taxability of Leave Encashment

Calculation of Average Monthly Salary

Average monthly salary is calculated by considering the monthly salary received by the worker within the last ten months immediately preceding the cessation of services. The components of calculation include basic pay, dearness allowance, and commission supported by the fixed percentage of turnover achieved by the employee; and wouldn’t include any allowances or perquisites.

Post by Sreeram Viswanath

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