Leave Encashment Rules in India: Calculation and Tax
When unused leave must be paid out under the OSH Code, how to calculate leave encashment, and how it is taxed while in service and on resignation.
Short answer: leave encashment is paying an employee cash for earned leave they did not take. It happens when they leave the job, and, under the Occupational Safety, Health and Working Conditions (OSH) Code, at the end of a calendar year when the worker asks for it. The usual calculation is (basic + DA) ÷ the divisor in your policy × days of leave. On tax: encashment while still employed is fully taxable as salary; on retirement or resignation, a private-sector employee gets an exemption capped at ₹25 lakh over their working life.
What the OSH Code says about earned leave
Section 32 of the OSH Code, in force with the other labour codes since 21 November 2025, sets the floor for "workers":
- A worker becomes entitled to leave in a calendar year after working 180 days or more in that year.
- Leave accrues at one day for every 20 days worked.
- Unused leave can be carried forward to the next year, up to 30 days. Leave that was applied for and refused can be carried forward without that limit.
- The worker can ask for encashment at the end of the calendar year.
- A worker who is discharged, dismissed, quits, retires or dies gets wages for the leave accrued, even if they had not reached 180 days. On discharge, dismissal or quitting, this is due before the second working day; on superannuation or death, within two months.
Two cautions. The Code's leave provisions protect "workers", which leaves out people employed mainly in managerial or administrative roles and some supervisory staff. And many offices are also covered by their state's Shops and Establishments Act, which has its own leave and encashment rules. Your policy has to meet whichever is more generous, so check both with your CA or labour consultant.
When leave is encashed in practice
| Situation | What happens |
|---|---|
| End of the calendar year | Leave up to the carry-forward limit rolls over; the worker can ask for encashment. |
| Resignation or termination | All accrued, unused earned leave is paid in the final settlement. |
| Retirement or death | Paid to the employee, or to the nominee or heir, within two months. |
| Casual and sick leave | Usually lapse at year end; encash them only if your policy says so. |
How to calculate leave encashment
The formula most Indian employers use is:
Leave encashment = (Basic + DA) ÷ divisor × number of leave days
The divisor is where companies differ. Some divide by 30, some by 26 (30 days less four Sundays), and some by the actual days in the month. The OSH Code ties leave wages to "wages" as defined in the Code on Wages, which is basic, DA and retaining allowance — plus any excluded allowances above half the total pay. Whatever divisor you choose, write it into the leave policy.
Worked example
Meena's basic is ₹36,000 and DA ₹4,000, so ₹40,000 a month. She resigns with 25 days of earned leave.
| Divisor | Per-day value (₹) | 25 days (₹) |
|---|---|---|
| 30 | 1,333.33 | 33,333 |
| 26 | 1,538.46 | 38,462 |
The same leave is worth ₹5,129 more on a 26-day divisor. Neither is wrong, but switching between them for different employees is how disputes start.
How leave encashment is taxed
While still employed
Leave encashed during service, including at year end, is taxed in full as salary in the year it is received. Deduct TDS on it with the month's salary.
On retirement or resignation
Government employees are fully exempt. For everyone else, the exempt amount is the least of:
- The amount actually received.
- ₹25 lakh, the limit that applies from 1 April 2023 under CBDT Notification 31/2023. This is a lifetime limit: exemptions claimed from earlier employers count towards it.
- Ten months' average salary, based on the ten months before leaving.
- The cash equivalent of unused leave, counting no more than 30 days for each completed year of service.
"Salary" here means basic and DA. Anything above the exempt amount is taxable as salary.
This exemption was section 10(10AA) of the Income-tax Act, 1961. From 1 April 2026 the Income-tax Act, 2025 replaced the old Act and the exemptions were reorganised; we have not given the new reference because we could not confirm it, so ask your CA which provision to cite in the return.
Tax example on resignation
Meena has eight completed years of service and ₹40,000 of basic and DA. Her company credits 30 days of leave a year and she has 90 days unused, encashed at ₹1,333.33 a day = ₹1,20,000. The four limits are ₹1,20,000, ₹25 lakh, ₹4,00,000 and ₹1,20,000. The least is ₹1,20,000, so the whole encashment is exempt, provided she has not used up the ₹25 lakh with earlier employers.
A leave policy that avoids disputes
- Name each leave type and say which ones can be carried forward or encashed.
- State the carry-forward limit and what happens to leave above it.
- State the divisor and the pay elements used.
- Keep a running balance per employee that both sides can see.
Most of the arguments come from the last point. If leave is applied for on WhatsApp and tracked in a sheet, nobody trusts the balance at exit. Our post on leave management software covers how to fix that, and our full and final settlement guide shows where encashment fits in the final payment.
Where Grovia fits
Grovia's HR module records leave requests by type, with dates, number of days, approval and the approver's note, and the monthly payroll entry carries leave days alongside present days. It does not calculate leave encashment or its tax exemption; you work out the amount and add it to the payroll entry.
Figures checked on 1 November 2026. Tax and labour rules change, and several states are still finalising their rules under the labour codes; confirm the current position with your CA before you act on it.
Grovia runs leave, attendance and payroll alongside leads, quotations, GST invoices, payments and your team in one place. Start a free 14-day trial (no card needed).
Frequently Asked Questions
How is leave encashment calculated in India?
Usually as (basic + DA) divided by the divisor in your leave policy, commonly 30 or 26, multiplied by the number of unused earned leave days.
Is leave encashment taxable?
Encashment during service is fully taxable as salary. On retirement or resignation, non-government employees get an exemption up to the least of four limits, with ₹25 lakh as the lifetime cap; government employees are fully exempt.
How many days of leave can be carried forward under the OSH Code?
Up to 30 days of unused leave can be carried forward to the next calendar year. Leave that was refused can be carried forward without that limit.
Is casual leave encashable?
Not by law. The statutory rules cover earned leave; casual and sick leave are encashed only if your own policy allows it.
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