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Quick answer: Leave encashment is the money an employee gets for earned leave they didn’t use. Under the OSH Code (in force since 21 November 2025), workers can carry forward up to 30 days of leave and encash the excess at the end of the calendar year. It’s usually calculated as (Basic + DA) ÷ 26 × unused leave days. Encashment during service is fully taxable; on resignation or retirement, private-sector employees get a tax exemption of up to ₹25 lakh.
If you run payroll in India, leave encashment is one of those things that looks simple until December arrives. Who gets paid for which days? Do you divide by 26 or 30? Is it taxable this time? And what changed when the Labour Codes kicked in?
This guide answers all of it, with the actual numbers, worked examples and the tax maths, so you can get it right the first time.
Short on time? Use our free leave encashment calculator and get the amount in seconds.
Key takeaways
Only earned leave (EL) or privilege leave (PL) is normally encashable. Casual and sick leave usually lapse.
Under the OSH Code, workers become eligible for annual leave after 180 days of work in a year (down from 240 days under the Factories Act).
Up to 30 days can be carried forward. Anything above that can be encashed at the end of the calendar year.
Leave an employer refused can be carried forward with no cap.
The tax-free limit on leave encashment at exit is ₹25 lakh for private-sector employees, up from ₹3 lakh (a figure set back in 2002). That’s more than eight times higher.
State Shops and Establishments Acts still apply, and several allow 45 days of accumulation, so check both.
What is leave encashment?
Leave encashment means converting unused paid leave into cash. Employees earn leave for the days they work. When they don’t take all of it, the balance is either carried forward or paid out. The payout is leave encashment, also called “leave salary” in tax law.
Not every type of leave qualifies:
Type of leave | Usually encashable? | Notes |
|---|---|---|
Earned leave / privilege leave | Yes | The main encashable leave, by law and policy |
Casual leave | No | Lapses at year-end in most states |
Sick leave | No | Some companies allow it by policy, but the law doesn’t require it |
Compensatory off | No | Usually expires within a set period (often 30–90 days) |
Maternity / paternity leave | No | Can’t be encashed; it’s a separate statutory benefit |
Leave refused by the employer | Yes | Carried forward without the 30-day cap under the OSH Code |
Leave encashment rules under the new Labour Code (OSH Code, 2020)
The Occupational Safety, Health and Working Conditions Code brought annual leave for “workers” under one national standard from 21 November 2025. Here’s how it compares with the old rules:
Rule | Before (Factories Act, 1948) | Now (OSH Code, 2020) |
|---|---|---|
Eligibility for annual leave | 240 days worked in a year | 180 days worked in a year |
Leave earned | 1 day per 20 days worked (adults) | 1 day per 20 days worked |
Carry forward | Up to 30 days | Up to 30 days |
Excess above the carry-forward limit | Often lapsed | Worker can encash it at year-end |
Encashment during service | Depended on policy and state | Worker can request it at the end of the calendar year |
Leave refused by the employer | Carried forward without limit (factories only) | Carried forward without any cap |
Encashment on exit | Payable | Payable |
The rule payroll teams most often miss is the one about refused leave. Factories already had it; the OSH Code now applies it to all workers. As lawyers at JSA Advocates point out, if a worker applies for leave and you turn it down, that leave doesn’t count towards the 30-day cap. So keep a clean record of every refusal.
Who counts as a “worker”? The OSH Code’s leave rules apply to workers. Employees in managerial or administrative roles, or supervisors above the notified wage limit, may fall outside that definition. For them, your leave policy and state law decide.
Are the rules fully in force? The Code is in force, but labour is a shared subject. Each state notifies its own rules, and some are still finalising them. Until your state’s rules are clear, follow whichever of the Code or your state Act is more beneficial to the employee.
State rules on leave accumulation and encashment
Offices, shops, and service businesses also fall under their state’s Shops and Establishments Act. These set their own earned leave quotas and accumulation limits:
State | Earned leave a year (Shops Act) | Maximum accumulation |
|---|---|---|
Maharashtra | 21 days | 45 days |
Karnataka | 18 days | 45 days (raised from 30 in 2023) |
A few more state points worth knowing:
Telangana lets non-exempt employees encash earned leave while still in service, not just at exit.
Most states require all accrued earned leave to be paid out when an employee leaves.
Some states allow 45–60 days of accumulation, which is more than the OSH Code’s 30-day carry-forward. How the two interact for a given employee is still being worked out, so take advice for multi-state teams.
State Acts are amended often. Check the current notification for each state you operate in before you set your policy.
Leave encashment formula
The formula most Indian companies use:
Leave encashment = (Basic + DA) ÷ 26 × number of unused earned leave days
Why 26? It’s the number of working days in a month with four Sundays off, and it’s the same divisor the gratuity formula uses. Some companies divide by 30 or by the actual days in the month instead. The divisor you pick changes the payout, so write it into your leave policy.
Here’s what the choice does to 10 days of encashment on Basic + DA of ₹30,000:
Divisor | Per-day rate | Encashment for 10 days |
|---|---|---|
÷ 26 (working days) | ₹1,154 | ₹11,538 |
÷ 30 (calendar month) | ₹1,000 | ₹10,000 |
÷ 31 (actual days in a 31-day month) | ₹968 | ₹9,677 |
That’s a gap of almost ₹1,900 for one employee and ten days. Across a team of 200, it adds up fast.
ZFour’s free calculator uses the 30-day method. Whichever divisor you choose, write it into your leave policy and use it for every employee.
Basic + DA or gross? Most employers use Basic + DA, which matches the core of “wages” under the Labour Codes. Some policies use gross salary. Either is fine as long as the policy says so and you apply it the same way to everyone.
Leave encashment calculation: 4 worked examples
Example 1: Year-end encashment of excess leave
Ravi works on the shop floor of a factory in Pune. His Basic + DA is ₹26,000 a month. On 31 December, he has 40 days of earned leave.
He carries forward 30 days, the maximum.
The other 10 days are encashed.
Per-day rate: ₹26,000 ÷ 26 = ₹1,000
Leave encashment: ₹1,000 × 10 = ₹10,000, paid in January payroll and taxed as salary.
Example 2: Encashment on resignation
Priya, a sales coordinator in Gurgaon, resigns with 22 days of earned leave. Her Basic + DA is ₹39,000 a month.
Per-day rate: ₹39,000 ÷ 26 = ₹1,500
Leave encashment: ₹1,500 × 22 = ₹33,000, paid in her full and final settlement within two working days of her last day.
Example 3: Leave refused by the manager
Amit applied for 12 days of leave in October, but his manager refused it because of a delivery deadline. On 31 December he has 42 days in total.
30 days carry forward under the normal cap.
The 12 refused days also carry forward, outside the cap.
Nothing lapses. Amit can encash those days later, at the end of a calendar year or when he leaves.
Example 4: Partial month and loss of pay
Most companies calculate leave encashment on the employee’s regular monthly Basic + DA, not the reduced pay from a month with loss-of-pay (LOP) days. If Neha’s Basic + DA is ₹33,800 but she had 3 LOP days in her last month, her encashment rate is still ₹33,800 ÷ 26 = ₹1,300 a day.
The payout examples side by side
Employee | Basic + DA (₹/month) | Days encashed | Per-day rate (÷26) | Encashment |
|---|---|---|---|---|
Ravi (year-end excess) | 26,000 | 10 | ₹1,000 | ₹10,000 |
Priya (resignation) | 39,000 | 22 | ₹1,500 | ₹33,000 |
When is leave encashment paid?
Situation | When it’s paid | Legal basis |
|---|---|---|
Excess over the 30-day carry-forward limit | End of the calendar year | OSH Code |
Worker asks for encashment | End of the calendar year | OSH Code |
Resignation, termination or retirement | In the full and final settlement, within 2 working days of the last day | State law and leave policy (final settlement due within 2 working days) |
Death of the employee | To the nominee or legal heirs | Company policy and state law |
During service by company policy | As the policy states (e.g. every April) | Leave policy |
If someone is leaving, leave encashment sits alongside their pending salary, gratuity and any notice period recovery in the final settlement.
Is leave encashment taxable?
It depends on when the money is paid. This is the part most employees, and quite a few payroll teams, get wrong.
When it’s paid | Who | Tax treatment |
|---|---|---|
During service (e.g. year-end) | Everyone | Fully taxable as salary |
On retirement or resignation | Central and state government employees | Fully exempt |
On retirement or resignation | Private-sector, PSU and bank employees | Exempt up to the lowest of four limits; ₹25 lakh lifetime cap |
After death, to legal heirs | Everyone | Not taxable |
The exemption works under both the old and the new tax regime. Since 1 April 2026, it sits in Section 19 of the Income-tax Act, 2025. Before that, it was Section 10(10AA) of the 1961 Act. The ₹25 lakh limit carries over unchanged. The law refers to retirement “on superannuation or otherwise." Resignation is generally treated as eligible by courts and tax practitioners, though older CBDT guidance read it more narrowly, so check unusual cases with a tax adviser.
The four-limit test (private-sector employees)
The tax-free amount is the lowest of:
Leave encashment actually received
₹25,00,000, reduced by any exemption claimed in earlier years
10 months’ average salary
Cash value of unused leave, counting at most 30 days for every completed year of service
“Average salary” means average Basic + DA (plus commission, if it’s a fixed percentage of turnover) over the 10 months before leaving.
Worked tax example
Suresh resigns after 15 years. His average Basic + DA over the last 10 months is ₹80,000. His last drawn Basic + DA is ₹85,000. He has 200 days of unused earned leave, and he’s never claimed this exemption before. His employer pays him ₹85,000 ÷ 26 × 200 = ₹6,53,846.
Limit | Calculation | Amount |
|---|---|---|
1. Actually received | — | ₹6,53,846 |
2. Statutory cap | ₹25,00,000 − ₹0 claimed earlier | ₹25,00,000 |
3. 10 months’ average salary | ₹80,000 × 10 | ₹8,00,000 |
4. Cash value of unused leave | ₹80,000 ÷ 30 × 200 days (within the 30-days-a-year cap of 450 days) | ₹5,33,333 |
Exempt (lowest) | ₹5,33,333 | |
Taxable | ₹6,53,846 − ₹5,33,333 | ₹1,20,513 |
Suresh pays tax only on ₹1,20,513, added to his salary income for the year.
Tax relief on in-service encashment
Year-end encashment is fully taxable. But if it bunches several years’ leave into one payout and pushes the employee into a higher slab, they can claim relief under Section 89 by filing Form 10E on the Income Tax e-filing portal before filing their return.
7 leave encashment mistakes employers make
No divisor in the policy. Using 26 for some employees and 30 for others is an easy dispute to lose.
Letting excess leave lapse. Under the OSH Code, leave above 30 days can’t simply disappear for workers.
Not tracking refused leave. Refused days sit outside the cap, and you need the records to prove which days they were.
Encashing casual or sick leave by accident. It inflates the payout and the tax.
Wrong TDS at exit. Deducting tax on the full amount, without applying the four-limit test, overcharges the employee.
Not asking about earlier exemptions. The ₹25 lakh cap is lifetime. Ask departing employees, in writing, whether they’ve claimed it before.
Late final settlement. Wages on exit are due within two working days under the Code on Wages, and leave encashment is normally paid in the same settlement.
Leave encashment checklist for HR and payroll
Write the encashment rules into your leave policy: which leaves, which divisor, which pay components
Map each location to its state Shops and Establishments Act and note its accumulation limit
Log every refused leave request with the date and reason
Run the year-end carry-forward and encashment in the December or January payroll
Treat in-service encashment as taxable salary and deduct TDS
Apply the four-limit test before deducting TDS at exit
Pay leave encashment in every full and final settlement within two working days
Show the exempt and taxable parts separately in Form 16
Calculate leave encashment in seconds
Enter Basic + DA and your unused leave days, and our free leave encashment calculator works out the payout. It uses a 30-day month by default, so if your policy divides by 26, the amount per day will be slightly higher than the calculator shows.
How ZFour handles leave encashment for you
Doing this by hand works for ten people. At fifty, December turns into a spreadsheet marathon. ZFour’s leave management system takes care of it:
Accrues earned leave automatically at 1 day per 20 days worked, or your state’s rate
Applies the right carry-forward limit for each location
Tracks refused leave separately, outside the cap
Moves year-end encashment straight into payroll with TDS
Adds leave encashment to the full and final settlement and applies the four-limit tax test
Related reading
Leave management system: automate accruals, carry-forward and encashment
Free HR calculators, including gratuity and leave encashment
References
This article is for general information and isn’t legal or tax advice. Leave rules depend on your state and employee category; check the rules that apply to your establishment.
Farheen Ahmed
HR Tech Content Strategist at ZFour Technology Private Limited
Research-driven content on HRMS, payroll, attendance management, employee management, and modern HR technology for Indian businesses.
