In the organised sector, employees are allowed various categories of paid leaves like sick leave, casual leave and privilege leave. Employees are allowed to carry forward some categories of paid leaves whereas other leaves not availed during the year simply lapse.
Employers generally allow employees to carry forward their privilege leave only up to a certain limit, beyond which this leave also lapses. Again, some employers allow their employees to encash some of accumulated leaves either during the continuance of their employment or at the time of leaving their job either on resignation or at the time of reaching the age of superannuation.
The rules as regards carry forward and encashment differ from company to company. The income tax rules provide for taxation and exemption in respect of encashment of such leaves. Let us discuss the taxation aspect of encashment of leaves.
Tax treatment of encashment of leave at the time of retirement or on resignation
A) Rules applicable to government employee
Income tax laws allow certain exemptions in respect of the money received for encashment of leave at the time of leaving the job. The rules are different for government employees whether Central government or state government and other employees. For government employees, the money received for encashment of leave is fully exempt without there being any upper monetary limit or as to the number of days leave encashed.
Please note that the exemption is available only to the government employees and not to those who are working in companies owned by governments. So, the exemption is available to employees working in revenue departments, government ministries, railways etc. but the blanket exemption is not available to employees working in public sector undertakings like banks, insurance companies etc.
B) Rules for non-government employee
For those employees who are not covered as government employee as explained above, there is an overall limit of three lakh rupees up to which leave encashed is exempt at the time or leaving the company. There is also a cap for exemption with respect to the number of days of leave encashed. So such employees can claim exemption only for 15 days of accumulated leave for each year of service subject to a maximum of leave equal to ten months’ leave.
The amount is to be calculated with reference to the average salary drawn by the employee during the last ten months before his retirement. It is important to understand that the exemption upto three lakh rupees is available in aggregate in respect of leave encashment received from all the employers during the life time of an employee. So, in case you have already availed exemption for leave encashment in the past, the exemption available in respect of the current employer will have to be reduced by exemption already claimed in the past.
Taxation of leave encashment availed during continuance of employment
Some employers allow their employees to encash their accumulated leave during the continuance of the employment. No exemption is available in respect of leave encashment during continuance to the employer and is treated as your salary. The exemption in respect of leave encashment is available only when the employee leaves the organisation and not otherwise. So, in case you encash leave while continuing the employment with the current employer, the amount received will be fully taxable in your hands and the employer will deduct the applicable tax.
(The author is a tax and investment expert, and can be reached at email@example.com)