What is leave encashment?
Leave encashment can be defined as the process wherein employees can get monetary returns in exchange of their unused leave balance. In simple terms employees receive remuneration basis their current salary for the leaves which we assigned to them but remain unused. Leaves can also be encashed in exchange of a complimentary off/incentive given by the company to the employees who have either worked on a public holiday or an assigned holiday.
What are the types of leave that can be encashed?
Every company differ in their leave types; here are the mostly utilized categories which leaves are divided in
This is also known as annual or privilege leaves. Here employees are eligible for a certain n umber of annual leaves that can be taken with a prior intimation. These leaves if remain unused, generally carry forward for the next financial year and employee can be compensated for the same later when they leave the organization.
Sick leaves are commonly known as medical leaves and are given to the employees who require leaves due to health-related issues. In most cases, these are unplanned leaves and are taken during emergencies, thus does not require prior approval. In case of long absence organizations can ask to produce a medical certificate. Sick leaves cannot be encashed and generally lapse at the end of the year. However, all organization’s policy differs, and the rule doesn’t have to be similar everywhere.
These are fixed number of leaves that an employee gets on annual/monthly basis. They can be utilized for any purpose, requires prior approval. These leaves generally do not lapse at the end of the financial year and can be compensated later if remain unused.
Read more: The Future of Leave Attendance Management
What is leave encashment policy?
A leave encashment policy is a formal guideline set by an organization that allows employees to get compensated for their unused paid leaves. In most cases, employees accumulate their leaves which carry forward to the next financial year and get monetary benefits basis their current salary composition after a certain tenure or at the time of resignation/retirement etc.
Although not every company has the similar leave policies, thus, the composition and rules to avail the compensation can differ. The formula used to calculate the payout is-
(Basic salary + dearness allowance), divided by 30, multiplied by unused leave days
Is the leave encashment amount taxable?
Yes, the leave encashment amount comes under tax compliance, however, the rules may vary basis the employee situation and the type of employment.
Tax norms are different globally, so the kind of rules levied would differ according to the geographical location.
Read Here: Everything You Need to Know About Payroll
Factors Affecting the Leave Encashment Exemption
There are multiple factors that influence on how much leave encashment should be exempted from tax, specifically for public sector employees.
According to Indian norms, government employees are fully exempted at the retirement, however, the private employees are partially exempted subject to limits.
When employees encash leaves during their service time, it is fully taxable. In case of encashment asked during retirement or resignation, it is eligible for exemption.
- Tenure in the Organization
Exemption is calculated also basis the number of leave days in the balance and how much tenure has the employee completed in the organization.
The chosen tax regime also affects the exemption, as it is allowed under the tax regime which is based according to the geography.
- Salary of the Last 10 Months
Exemption calculation has rules, it is mostly calculated basis last 10 months' salary.
Tax exemptions on leave encashment
According to Indian tax regime governed by section 10(10AA) of income tax act, here are the tax norms basis employment type and timing.
Government employees are fully exempted from tax when leave encashment is received at the time of retirement.
Private employees are partially exempted at the time of retirement or resignation, there are few aspects taken in consideration-
- Lifetime limit for exemption is INR 25,00,000
- 10 months of average salary (basic + DA + eligible + commission)
- Cash equivalent of leaves is maximum for 30 days or the year of service
Conclusion
Leave encashment is undeniable a crucial aspect for employee satisfaction and an imperative factor which constitutes employee compensation and benefits. It is imperative to understand the importance, calculation method, benefits and the process by which it can be availed.
However, organizations require professional help to make the right calculations and never let their employee seem dissatisfied. HONO is a complete HCM solution which not only helps in easing HR operations but can seamlessly integrate with your organizational structure and let you run HR error free.
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