Leave Encashment & Its Tax Implications

The process of Leave Encashment

Salaried employees working in government and private sector, however, get nearly equal work benefits regarding their pay scale, tax deductions and leaves. The employee is subjected to pay income tax if their annual income exceeds the limit as advised by the income tax department. The employer deducts some amount from the employee’s salary account and deposits that amount in the provident fund (PF) account. The provident funds are accessible for the employee throughout their employment period and after retirement. The employer also offers incentives and allowances like travel, food, accommodation for the employee during their employment period. There are insurance policies provided by the organization for the employees through which they can claim them during health emergencies and use the matured amount after retirement. However, an employee can carry forward their leaves if not used in the year and can later ask for encashment on behalf of the leaves untaken. This process is known as leave encashment and every employee can get its benefits.

What is Leave Encashment?

Leave encashment is a leave carry forward process provided by the organization to the employee and it can be availed on unused leaves of the employee.As these leaves get credited every year, the employee can ask for encashment at the time of their resignation from the company or after retirement. The organization keeps data of the used and unused paid leave by the employee and balances at the end of the employment period. The employee can receive a day’s salary for every paid leave day in the encashment process. This process is valid for every employee working in the organization. Before that, let's get to know about the types of leaves employees can get and its benefits for further leave encashment.

Types of Leaves and Leave Encashment

Employers also provide various types of leaves other than holidays for the employees. In order to have a good balance between work and personal life the organization offers multiple leaves for their employees during their work tenure. Besides, the leaves provided are categorized as paid and unpaid leaves. The types of employment leaves are:

Providing such leaves has multiple benefits for employees as well as for the organization. In case of any medical emergency or health conditions employees can avail medical leaves which are extendable. Maternity and paternity leaves are very important and useful working women during their pregnancy. Holidays are the perfect leaves where employees can enjoy festivals and their time with their loved ones. Availing sabbatical or study leaves can really help employees to advance their knowledge levels and skills further adding more flexibility and confidence while working. Organizations get a lot of benefit from the study leaves as employees trained with new skills and knowledge add more to the organization thus improving business. Paid leave granted by the organization lets employees balance their work-life and creates a sense of trust while working with the organization. Perhaps organizations have to take care of their employees in all conditions and employees should in return the generosity by giving their best working performance.

Labour Act : A Guideline for Employers and Employees

Every organization provides working guidelines to its employees based on the regulations of labour law. The labour law lays regulations regarding the terms and conditions of employment, discrimination, employment leave rights, employee representation and employee privacy rights. All organizations working in India should comply with these regulations and provide guidelines to their employees. The regulations set by the Labour Act ease the recruitment process of an employee, their agreements with the organization, basic pay scale provided as per minimum wages and other employee protection guidelines. Rights regarding leaves for the employee taken during the employment duration should comply with the Labour Act. Therefore organizations should always follow regulations provided in order to secure employee rights.

Leave Encashment and Tax

During employment period

Any employee demanding leave encashment for their unused paid leave during their employment period is taxable as it is considered as income from salary. In this case, the employee can get tax relief under Section 89. As per Section 89, the employee can claim tax relief from the amount received through the leave encashment process. In order to get tax relief for leave encashment, the employee should file form 10E. This form is easily available on the e-portal of the income tax department and once filled can be submitted online. The only tax is paid during the encashment will be income tax from salary.

After retirement or resignation

At the time of retirement or resignation, the employee can avail encashment through their accumulated paid leave. However, there are various conditions depending upon the type of organization in which the employee has worked.

• When the employee has worked in the central or state government organization, they can fully claim for their paid leave encashment and that too with full exemption from tax.
• In the case of employee’s death before the leave encashment, their legal heirs can receive total leave encashment on behalf of the deceased. No income tax will be charged on the amount received by them.

Employees working in the private sector can receive paid leave encashment at the time of retirement or resignation.Maximum tax exemption amount is Rs 3, 00,000 for the leave encashment otherwise amount exceeding this value is taxable. The calculation of exempt leave encashment os as per section 10(10AA)

Tax Exemption Under Section 10(10AA)

In such a case, the following points are considered in order to receive the exemption under section 10(10AA).

• The leave encashment amount actually received is taken into account
• The average salary of 10 months. The salary includes basic salary and dearness allowances. Also, the commission received is considered. The salary of 10 months actually considered is on the basis of salary received during the 10 months preceding their retirement or resignation.
• Even if the employee has accumulated number of leaves in a year, the organization will consider only a maximum of 30 days of leave a year for the encashment process. According to it, the total number of paid leaves will be calculated altogether during the retirement or resignation and then encashment will be processed further. Suppose a person has not utilized all the paid leaves and it accounts for 45 days still the organization will only consider 30 days of paid leave for encashment at the time of resignation or retirement.
• In the case of leave encashment during the employment period the amount received will totally be taxable in all forms. But according to Section 89, Income Tax Act, the employee can claim for tax relief from their leave encashment amount.
• For employees who have retired after 1998, their leave encashment amount is subjected to a maximum limit of Rs. 3, 00,000 to be received which is specified by the government. When the actual amount to be received will be more than Rs. 3, 00,000, then 3, 00,000 will be received as the encashment amount and the remaining amount will be received in the salary account which will be taxable. This case applies only for non-government employees.
• The legal heirs of deceased employees at the time of leave encashment can receive the amount without any form of tax deduction from the amount.
• In case of resignation or termination, both government and non-government employees are held to pay the tax on the amount received from paid leave encashment because the amount at the time is considered as income from salary by the income tax department. The rate of tax to be paid is applied same as during income tax on salary.

To make it easy to understand, here is an illustration:

Mohan has retired from the organisation after serving for a period of 20 years. He was entitled to 32 days of paid leave in a year.But he exhausted leave 275 and left with 365 days of leave.He draws basic salary +D.A INR 30000 per month at the time of retirement. He received leave encashment of INR 365000 (365*1000).

Taxable leave encashment will be:
Actual amount received : INR 365000
Average Salary of 10 months: 300000
(30*20-actual leave taken)*1000 = 325000
Maximum Allowed: 300000
Lower of all is exempt i.e. INR 300000
Therefore, taxable leave encashment will be 65000(365000-300000)

Conclusion

Hence, leave encashment process is totally transparent and easy to avail by employees during or after their employment period. The government of India has provided the Labour Act according to which the employees should get equal rights, leaves and wages. The leave encashment policy works the same for every employee. This encashment amount can further be useful for important things like healthcare, education of their children and personal savings. Considering the cost of inflation the leave encashment can be received during the employment period or after retirement. The employee can decide whether to receive a one-time amount or in stages. When the amount is large, employees should plan their tax returns accordingly.