Leave encashment is payment for earned leave you haven’t taken. In a private company in India, it is usually paid when you leave the job, under your state’s Shops and Establishments Act (or the Factories Act, 1948) and your contract. Casual and sick leave usually lapse instead. At exit, encashment is tax-exempt up to the limits in section 10(10AA) of the Income-tax Act.
This guide is for employers writing a leave policy and for employees checking their full and final settlement. It explains where each rule comes from, works through a leave encashment calculation, and covers how to keep leave balances accurate. It is general information, not legal or tax advice: rules differ by state and are changing as the new labour codes take effect, so check the law that applies to you.
Where do leave rules come from?
There is no single national leave law for private offices. Three sources decide what an employee gets:
| Source | Covers | What it sets |
|---|---|---|
| State Shops and Establishments Act | Offices, shops, IT companies and most other businesses in that state | Minimum earned, casual and sick leave, carry-forward limits, payment on exit |
| Factories Act, 1948 (sections 79 and 80) | Factories | Earned leave (“annual leave with wages”) and how it is paid |
| Employment contract and leave policy | Every employee | Anything above the legal minimum, plus the details the law leaves open |
A policy can always give more than the law, never less. So the first step is to find the Act for the state where the employee works; each state sets its own number of days, qualifying period and carry-forward cap.
What types of leave do private employees get in India?
- Earned leave (EL), also called privilege or annual leave. Built up by working, used for planned time off, and usually carried forward up to a cap.
- Casual leave (CL). A few days a year for short, unplanned absences. Usually lapses at the end of the year.
- Sick leave (SL). For illness; many policies ask for a medical certificate after a set number of consecutive days.
- Maternity leave. 26 weeks for the first two children in establishments with ten or more employees, under the Maternity Benefit Act, 1961 as amended in 2017 (now part of the Code on Social Security, 2020).
- Public holidays. Separate from leave. Republic Day, Independence Day and Gandhi Jayanti are observed nationally, and each state notifies its own festival holidays.
Paternity leave, bereavement leave and “wellness days” are not required by law for private companies, but many offer them. If you do, write them into the policy so they are applied the same way to everyone.
What are the earned leave rules?
The Factories Act gives the clearest example of how earned leave builds up. Under section 79, an adult worker who has worked at least 240 days in a calendar year earns one day of leave with wages for every 20 days worked, to be taken the following year. Unused leave can be carried forward, up to a total of 30 days.
So someone who worked 260 days last year earns 260 ÷ 20 = 13 days of earned leave this year.
State Shops and Establishments Acts follow a similar pattern: a qualifying period, an annual entitlement, and a cap on how much can be carried forward. Many companies simplify this by crediting earned leave monthly (for example 1.5 days a month for 18 days a year) as long as the result is at least what the Act requires.
What are the rules for casual and sick leave?
Casual and sick leave are set mainly by state Acts and company policy, so the details vary more than for earned leave. In most policies:
- casual leave covers short absences of a day or two and can’t be joined to earned leave for a long break
- neither casual nor sick leave is carried forward beyond the year, and neither is encashed
- sick leave beyond two or three consecutive days needs a medical certificate
Employees covered by the Employees’ State Insurance scheme can also claim sickness benefit from ESIC. That is a cash benefit paid by the scheme, separate from paid sick leave given by the employer.
What is leave encashment and when is it paid?
Leave encashment means being paid for earned leave you have not taken. It happens in two situations:
- On leaving the job. Resignation, termination or retirement. Unused earned leave is paid out in the full and final settlement. The Factories Act requires this (section 79(11)), and many state Acts do the same.
- While still employed. Some policies let employees encash part of their balance each year, or require it when the balance exceeds the carry-forward cap. This is a policy choice.
Only earned leave is normally encashed. Casual and sick leave are paid out only if the policy says so.
How is leave encashment calculated?
The formula is simple: unused earned leave days × daily rate. The daily rate is where most disputes come from, so the policy should state it. A common basis is basic salary (plus dearness allowance, if any) divided by 30 or by 26.
Worked example. An employee resigns with 12 days of unused earned leave. Their monthly basic salary is ₹36,000.
| Policy divisor | Daily rate | Encashment for 12 days |
|---|---|---|
| ÷ 30 (calendar days) | ₹1,200 | ₹14,400 |
| ÷ 26 (working days) | ₹1,384.62 | ₹16,615 |
Same employee, same leave, a ₹2,215 difference, purely from one line in the policy. Write the divisor down.
What is the tax exemption on leave encashment?
- Encashed while employed: fully taxable as salary in that year.
- Encashed on resignation or retirement: exempt up to a limit under section 10(10AA) of the Income-tax Act, 1961. For private-sector employees, the exempt amount is the lowest of:
- ₹25 lakh (the limit since 1 April 2023; it applies across your whole career, not per employer)
- the amount actually received
- ten months’ average salary (basic plus dearness allowance, averaged over the ten months before leaving)
- the value of unused leave, counting no more than 30 days of leave for each completed year of service
Anything above the lowest figure is taxable as salary. Government employees’ leave encashment at retirement is fully exempt.
The Income-tax Act, 2025, which applies from 1 April 2026, restates exemptions like this one under new section numbers. Confirm the current section and limit with your tax adviser before relying on them.
What changes under the new labour codes?
The four labour codes were brought into force in November 2025, with states notifying their own rules. The Occupational Safety, Health and Working Conditions Code, 2020 replaces the Factories Act. Among other changes, it lowers the qualifying period for annual leave from 240 to 180 days of work and allows workers to encash unused leave at the end of the calendar year.
The practical advice: review your leave policy against your state’s notified rules this year, rather than assuming the older Acts still apply unchanged.
How should a company track leave balances?
Most leave disputes are not about the law. They are about a balance nobody can explain. A few habits prevent them:
- Put the policy in writing: entitlements, when leave is credited, carry-forward caps, the encashment divisor and who approves what.
- Keep one leave ledger per employee that shows every credit, every day taken and every lapse, not just the current balance.
- Run the year-end on a fixed date: apply carry-forward caps, lapse casual leave, and tell employees their new balances.
- Handle exits the same way every time: calculate encashment from the ledger and show the working in the full and final settlement.
- Keep holiday calendars per location if people work in more than one state.
A spreadsheet works for a small team, but it breaks as soon as several managers approve leave. That is why we built leave management into WorkSpace: balances for casual, earned and sick leave are tracked automatically under your own policy rules, with public holiday calendars for each region. If your HR processes need something more tailored, we also build custom software around the way your company already works.
Questions about setting up leave tracking for your team? Get in touch.
Frequently asked questions
Can casual leave be carried forward?
Usually not. Casual leave is meant for short, unplanned absences, and most state Shops and Establishments Acts and company policies let it lapse at the end of the year. A few policies allow a small carry-forward; check yours.
Is leave encashment compulsory?
Paying for unused earned leave when someone leaves is required in many cases: the Factories Act, 1948 requires it (section 79(11)), and many state Shops and Establishments Acts have a similar rule. Encashing leave while still employed is normally a matter of company policy.
Is leave encashment taxable?
Leave encashed while you are still employed is taxed in full as salary. Leave encashed when you resign or retire is exempt up to a limit: for private-sector employees, the lowest of ₹25 lakh, the amount received, ten months' average salary, and the value of leave calculated at no more than 30 days per completed year of service.
Can an employer refuse leave encashment on resignation?
Not where the law or your contract gives you the right to be paid for unused earned leave. Some employers adjust unused leave against an unserved notice period, which is only valid if the contract or leave policy allows it. Ask for the calculation in writing with your full and final settlement.
Do interns get earned leave?
It depends on whether the intern is an employee under the applicable law and on the company's policy. Many stipend-based internships are not covered by statutory earned leave, but companies often give interns a few days of paid leave anyway. Write it into the internship letter.
