Jun 242016

Leave Encashment Rules Policy Calculation Formula Tax Exemption Under 7th Pay Commission

Leave encashment is the amount of money that an employee will get against his / her leave. The employees can convert their leaves into cash by not taking them during their services. Governmental as well as non-government employees can opt for leave encashment. There are three ways to receive the money, during the service or at the time of retirement, or at the time of resigning/termination. There is also tax exemption on the leave encashment. In 7th pay commission the rules have changed a little regarding leave encashment. Here in this article we will discuss the rules and how leave encashment gets calculated in detail.

Leave Encashment Rules Policy Calculation Formula Tax Exemption

Leave Encashment Rules and Eligibility

As per the rules a government employee or a non government employee both can take the facility of leave encashment. The rules for encashment are:

  • For government employee: leave encashment can take place during the service or at the time of retirement. If they en-cash their leave at the time of retirement, the amount will be exempted from the tax.
  • For non government employee: if they opt for leave encashment at the time of retirement the amount will be partially exempted from the tax.
  • For both employee: if they en-cash their leaves during their service the amount will be fully taxed.
  • The maximum limit of leaves for encashment is 60 days.
  • These 60 days are excluded from the maximum numbers of leaves in a year for any employee.

Leave Encashment Policy and Act

As per the Factories Act, the leave encashment must not exceed 60 days in a year. As per the act and policy of the encashment of the leave, the employee will receive the amount at the time of retirement or at the time of resignation/termination from the job.

Under section 79 (5) of the mentioned Act, the maximum numbers of days are said to be 30 days and if that exceeds the leave encashment will be nullified automatically. After 6th pay commission the number of days has been increased to 60 days. Some of the companies give away the leave encashment amount to their employees every year to lowering the liabilities.

Leave Encashment Calculation

The leave encashment depends on the basic salary of the employee. The leave encashment is being calculated on the basis of the monthly gross salary an employee is drawing. The gross salary consists of net pay and dearness allowances.

There is one mathematical formula that is used to calculate the leave encashment for a year of an employee. According to the formula, if an employee draws a salary of 10, 000/- per month including dearness allowances and is eligible to take leave 2 days per month, then the leave encashment will be:

Salary: 10, 000/- per month
Leave: 2 days per month
Leave encashment: (no of leaves x 12) x (gross monthly salary x 12 / 365)
Annual leave encashment here will be: (2×12) x (10000 x 12/ 365) = Rs. 7890.41/-

This is how the leave encashment is being calculated for a year. This amount is being paid either yearly or at the time of resignation / termination / retirement. It depends on the company’s policy.

Leave Encashment Formula

The formula for the calculation annual leave encashment is:

Annual leave encashment = (no of leave x 12) x (gross monthly salary x 12 / 365)

Leave Encashment Exemption, limit under Income Tax

Leave encashment is considered as a part of income. It is said to be income from the salary. Those who don’t take leaves instead encashing them need to pay income tax on the amount they receive. A portion of the amount is deducted from the annual leave encashment before the income tax is been imposed. The rest amount, if falls under the income tax slab, is been taxed according to the Factories Act.

According to the section 10 (10AA) of Factories Act, there are two categories of employees who can receive leave encashment.

  • Government employee: for both the state and central government employees, if the employee receives the leave cash at the time of retirement, the amount will be completely exempted from the income tax.
  • Other / non-government employee: for other employees the cash balance received as leave encashment can be taxed if it falls under income tax slab. So for the non-government employees, the amount will be fully or partially taxed.

There are some points to be noted to know how the taxing happens on the leave encashment:

  • The limit of leave encashment set by the government is Rs. 3. 00,000/-
  • Exemption on the average 10 months’ salary of the employee
  • The maximum limit of leave can be taken is 30 days a year.

Leave Encashment in 7th Pay Commission

After 7th pay commission the recommendation says:

  • Earned leave has been enhanced regarding the leave encashment
  • The maximum number of days for earned leave in service is 300 days at the time of retirement.
  • 300 days excluding the 60 days earned leave encashment during LTC

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