Most of the employees are entitled to certain no. of leaves per month/annum and leave encashment is simply encashing leaves remaining unutilised in the employee account. Leave encashment is the amount payable for the employee’s leave period, depending upon the leaves to his credit and his salary at the time of termination of employment or at the time of encashing his leaves.

Encashment of leave at any time during the employment is taxable in full. However, benefit of relief u/s 89(1) can be availed.
In the case of an employee of the Central Government or a State Government, any amount received as cash equivalent of leave salary in respect of the period of earned leave at his credit at the time of retirement/superannuation is exempt from tax.

In the case of a non-government employee (i.e., an employee other than an employee of the Central Government or a State Government) leave salary is exempt from tax to the extent of the least of the following:

a.    Cash equivalent of leave salary in respect of the period of earned leave to the credit of an employee only at the time of retirement whether on superannuation or otherwise (earned leave entitlements cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired); or

b.    10 months’ “average salary”; or

c.    The amount not chargeable to tax as specified by the Government i.e., Rs. 3,00,000/-; or

d.    Leave encashment actually received at the time of retirement.

Other relevant points
•    Here, Average Salary is to be calculated on the basis of average salary drawn during the period of 10 months immediately preceding the retirement or superannuation.   Salary means last drawn salary and includes basic salary + Dearness Allowance (if terms of employment so provide) + Commission based on a fixed % of turnover.

•    Where the cash equivalent of unutilised earned leave is received by an employee from two or more employers in the same year, or different years, the maximum amount exempt from tax shall not exceed the amount specified by the Government i.e., Rs. 3,00,000/-.
•    Salary paid to legal heirs of the deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is not taxable as salary.
•    Sum equivalent of leave salary received by the family of a government servant who died in harness, is not taxable in the hands of the recipients.

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