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What is Leave Encashment?
Leave encashment is the process of converting your unused earned leave (EL) or privilege leave into cash. In India, employees in the private sector are often entitled to encash a portion of their accumulated leave balance upon resignation, retirement, or sometimes even during employment, as per company policy and state labour laws.
How is Leave Encashment Calculated in India?
The calculation involves three key components: your daily wage, your encashable leave balance, and the applicable legal cap.
1. Daily Wage: This is determined by dividing your monthly 'Basic Salary plus Dearness Allowance (DA)' by a 'days base'. The base is typically 26 days if you work a 6-day week or 30 days for a 5-day week.
2. Encashable Leave Balance: You cannot encash your entire balance indefinitely. The Occupational Safety, Health and Working Conditions (OSH) Code, 2020, limits the encashment of earned leave to the equivalent of 30 days upon resignation. Your company policy may enforce a lower limit.
3. State-Specific Accrual: The rate at which you earn leave is governed by the Shops and Establishments Act of your state. Most states grant one day of earned leave for every 20 days of work performed.
Example Calculation
Rahul works in Maharashtra, has a Basic+DA of ₹60,000 per month, a 6-day work week (26-day base), and 40 days of unused earned leave.
- Daily Wage: ₹60,000 / 26 = ₹2,307.69
- Encashable Days: The lower of his balance (40 days) and the legal cap (30 days) = 30 days.
- Gross Encashment: ₹2,307.69 * 30 = ₹69,230.70
If this encashment occurs upon resignation and is his only such payment in the year, the first ₹25 lakh is tax-exempt under Section 10(10AA) of the Income Tax Act, so his entire ₹69,230.70 would be tax-free.
Common Scenarios
- Resignation: This is the most common trigger for leave encashment. Ensure you know your final leave balance and the company's processing timeline for the final settlement.
- Encashment During Service: Some companies allow partial encashment of leave while still employed. This amount is usually fully taxable as salary income.
- Retirement: The same calculation applies, and the ₹25 lakh tax exemption is specifically designed for this scenario.
Next Steps: Preparing the Right Document
If you are planning to resign and encash your leave, you should formally notify your employer. A Letter of Resignation from Employment is the essential first step. This document ensures you provide proper notice, state your last working day, and can optionally mention the expectation of a full and final settlement including leave encashment.
If you are not resigning but wish to request encashment of some leave days, you would use a formal Letter Requesting Leave, specifying 'Earned Leave Encashment' as the type of request in the body of the letter.